-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N3mAw9wFU+L/VngvmUs/yUzoaw4G9hdJvoD+o7vkGD9k2Gw/fmrhL/zfQw2QKKlW cJdZwLiwahcHPM5PY/aGlw== 0000825063-09-000034.txt : 20090831 0000825063-09-000034.hdr.sgml : 20090831 20090831151756 ACCESSION NUMBER: 0000825063-09-000034 CONFORMED SUBMISSION TYPE: N-CSRS PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20090630 FILED AS OF DATE: 20090831 DATE AS OF CHANGE: 20090831 EFFECTIVENESS DATE: 20090831 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN MUTUAL SERIES FUNDS CENTRAL INDEX KEY: 0000825063 IRS NUMBER: 222894171 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-CSRS SEC ACT: 1940 Act SEC FILE NUMBER: 811-05387 FILM NUMBER: 091045849 BUSINESS ADDRESS: STREET 1: 101 JOHN F KENNEDY PARKWAY CITY: SHORT HILLS STATE: NJ ZIP: 07078 BUSINESS PHONE: 973-912-2000 MAIL ADDRESS: STREET 1: 101 JOHN F KENNEDY PARKWAY CITY: SHORT HILLS STATE: NJ ZIP: 07078 FORMER COMPANY: FORMER CONFORMED NAME: FRANKLIN MUTUAL SERIES FUND INC DATE OF NAME CHANGE: 19970227 FORMER COMPANY: FORMER CONFORMED NAME: MUTUAL SERIES FUND INC DATE OF NAME CHANGE: 19920703 0000825063 S000007860 MUTUAL BEACON FUND C000021373 CLASS A TEBIX C000021374 CLASS B TEBBX C000021375 CLASS C TEMEX C000021376 CLASS Z BEGRX 0000825063 S000007861 MUTUAL GLOBAL DISCOVERY FUND C000021377 CLASS A TEDIX C000021378 CLASS B TEDBX C000021379 CLASS C TEDSX C000021380 CLASS Z MDISX C000021381 CLASS R TEDRX 0000825063 S000007862 MUTUAL EUROPEAN FUND C000021382 CLASS A TEMIX C000021383 CLASS B TEUBX C000021384 CLASS C TEURX C000021385 CLASS Z MEURX 0000825063 S000007863 MUTUAL QUEST FUND C000021386 CLASS A TEQIX C000021387 CLASS B TEBQX C000021388 CLASS C TEMQX C000021389 CLASS Z MQIFX C000078832 R 0000825063 S000007864 MUTUAL SHARES FUND C000021390 CLASS A TESIX C000021391 CLASS B FMUBX C000021392 CLASS C TEMTX C000021393 CLASS Z MUTHX C000021394 CLASS R TESRX 0000825063 S000007865 MUTUAL FINANCIAL SERVICES FUND C000021395 CLASS A TFSIX C000021396 CLASS B TBFSX C000021397 CLASS C TMFSX C000021398 CLASS Z TEFAX 0000825063 S000025452 Mutual International Fund C000076161 A C000076162 C C000076163 R C000076164 Z N-CSRS 1 fmsf-semiannual_0609.txt SEMI-ANNUAL MUTUAL SERIES UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-CSRS CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-05387 ------------- FRANKLIN MUTUAL SERIES FUNDS ------------------------------------ (Exact name of registrant as specified in charter) 101 JOHN F. KENNEDY PARKWAY, SHORT HILLS, NJ 07078-2705 ------------------------------------------------------------ (Address of principal executive offices) (Zip code) CRAIG S. TYLE, ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 --------------------------------------------------------------- (Name and address of agent for service) Registrant's telephone number, including area code: (210) 912-2100 -------------- Date of fiscal year end: 12/31 ------- Date of reporting period: 06/30/09 ---------- ITEM 1. REPORTS TO STOCKHOLDERS. JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" (GRAPHIC) VALUE MUTUAL SHARES FUND (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services. MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ..................................... 1 SEMIANNUAL REPORT Mutual Shares Fund ..................................... 4 Performance Summary .................................... 11 Your Fund's Expenses ................................... 14 Financial Highlights and Statement of Investments ...... 16 Financial Statements ................................... 32 Notes to Financial Statements .......................... 36 Shareholder Information ................................ 55
Shareholder Letter Dear Mutual Shares Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In the U.S. and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. During the period, the U.S. unemployment rate rose to its highest level in 25 years, housing prices continued their precipitous declines and 30-year U.S. Treasury yields plummeted to a 30-year low of around 2.5%, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of financial services companies on the scale of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of major bank nationalization was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The low in early March for the Standard & Poor's 500 Index -- down 26% from 2008 year-end and 57% from its peak in October 2007 -- was followed by a 42% rebound to its recent, second-quarter high on June 11.(1) The 57% drop was the third worst since 1900.(1) At the same time, yields on 30-year Treasuries shot up to 4.8% in (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Standard & Poor's 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The index is one of the most widely used benchmarks of U.S. equity performance. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 June, resulting in their worst six-month performance in over 16 years. European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed that the recovery in Europe would be slower than in the U.S. Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, the results of the government "stress test" of major financial institutions were generally positive, enabling many of those institutions to raise capital in the public markets and avoid a worst-case scenario of government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Additionally, the bankruptcies of General Motors and Chrysler, although particularly painful for dealers, suppliers and those directly dependent on the auto industry, were absorbed without triggering further systemic risk. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual Shares Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities, attractive merger arbitrage situations, and distressed debt opportunities. Consistent with the expectations outlined in our 2008 year-end letter, we added to companies in economically defensive industries, with strong market positions, high barriers to entry, and reasonably predictable earnings and cash flows, including companies in the consumer staples sector and the health care sector. We also anticipated purchases in some economically sensitive industries, and likewise increased our investments in some energy companies where we believe we found good value. Late in 2008 and early in 2009, we began to find opportunities in senior secured corporate loans trading at levels we perceived reflected mispriced risk. 2 | Not part of the semiannual report These are exactly the types of opportunities that we patiently wait for and that we had not seen since the last big credit default cycle of 2001-2003, which included the frauds at Enron, Tyco and WorldCom. On the bankruptcy front recently, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we like, although we expect more of these as "covenant lite," highly leveraged balance sheets eventually reach a tipping point. On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. However, a few large health care deals did emerge as those acquirers took advantage of their relatively stable cash flows and strong balance sheets to pursue a needed rationalization of the industry. The good news here is that we believe the potential returns for these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual Shares Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Shares Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 35% of its assets in foreign securities. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. We are pleased to bring you Mutual Shares Fund's semiannual report for the period ended June 30, 2009. PERFORMANCE OVERVIEW Mutual Shares Fund - Class Z delivered a +5.42% cumulative total return for the six months ended June 30, 2009. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which had a +3.16% total return for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the six-month period ended June 30, 2009, the U.S. economy and stock markets seemed to stabilize after signs appeared that the recession's severity had eased. Strains on the banking system and credit markets that surfaced in 2008 improved in 2009's first half with the help of federal aid and tighter regulations. Despite rising unemployment, near period-end home sales edged higher, the decline in manufacturing activity slowed and consumer confidence started to pick up. Economic activity as measured by gross domestic product (GDP) fell at annualized rates of 6.4% and an estimated 1.0% in the first and second quarters of 2009. Although the price of oil rose from $44 per barrel at the beginning of the period to $70 by period-end on speculation that the downturn was abating, it (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 21. 4 | Semiannual Report was still off more than 50% from its July 2008 record high.(2) June's inflation rate, as measured by the Consumer Price Index, was an annualized -1.4%, representing the steepest yearly decline in the cost of living in nearly six decades.(3) Core inflation, which excludes food and energy costs, rose at a 1.7% annualized rate, which was within the Federal Reserve Board's (Fed's) informal target range of 1.5%-2.0%.(3) A deepening recession and decelerating inflation prompted Washington policy-makers to keep interest rates low and enact stimulus plans -- including income tax cuts, aid to ailing state governments and funding for transportation infrastructure, school construction and high-tech projects. During the period under review, the Fed kept the federal funds target rate in a range of 0% to 0.25% and said the "pace of economic contraction is slowing" but the financial system had not yet returned to normal. Most U.S. stocks suffered major losses through early March as investors worried about an uncertain future. Stocks then recovered somewhat from 12-year lows as investors perceived many bargains among the bear market fallout and data indicated the economy's pace of contraction was moderating. By June, however, fresh investor concerns about the economy and stock valuations reemerged and dampened the rally's momentum. For the six months under review, the blue chip stocks of the Dow Jones Industrial Average had a total return of -2.01%, while the broader S&P 500 posted a +3.16% total return and the technology-heavy NASDAQ Composite Index returned +16.99%.(4) Global equities followed the same trend. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk appetite, rotating capital back into cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) U.S. 59.4% U.K. 9.5% Germany 4.4% France 4.2% Switzerland 3.1% Netherlands 2.8% Norway 1.3% Denmark 1.2% Other 4.6% Short-Term Investments & Other Net Assets 9.5%
(2.) Source: New York Mercantile Exchange. (3.) Source: Bureau of Labor Statistics. (4.) Source: (C) 2009 Morningstar. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. Semiannual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Tobacco 8.9% Insurance 7.0% Pharmaceuticals 5.7% Food Products 5.3% Food & Staples Retailing 5.3% Media 5.0% Beverages 4.3% Industrial Conglomerates 4.3% Oil, Gas & Consumable Fuels 3.8% Diversified Telecommunication Services 3.4%
the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. In the reporting period's final weeks, global equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(5) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(6) INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a (5.) Source: European Communities Eurostat. (6.) Source: People's Bank of China. 6 | Semiannual Report substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION During the first half of 2009, three of the Fund's best performing investments were oil and gas drilling company Transocean, U.K.-based cable services provider Virgin Media and software provider Microsoft. Transocean is a leading global provider of offshore drilling contract services for oil and gas companies. New drilling and seismic technologies have led to significant oil and gas discoveries in very deep water accessible only to modern, highly specialized rigs. The offshore drilling industry has benefited from these discoveries as customers entered into multi-year contracts at rates exceeding $500,000 per day. Transocean's shares appreciated dramatically as investors began to anticipate strong demand from Brazilian national oil company Petrobras for deepwater drilling rigs to develop the vast and recently discovered Tupi underwater oil field, an improving supply-demand picture for new deepwater projects, and better cost controls by the company. We continued to believe that the supply-and-demand outlook for deepwater drilling rigs was favorable. Virgin Media's share price rose after the company successfully extended the maturity profile of its debt and subscriber metrics, while pricing and profitability measures continued to show improvement. In addition, the company refocused on its core strength in data, leveraging its superior communications network to offer faster speeds than competitors. These efforts have proven effective as Virgin Media's subscriber trends outperformed market averages while the company also raised prices. Meanwhile, we believe consolidation among broadband communications companies in the U.K. market signaled a TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Wyeth 2.9% PHARMACEUTICALS, U.S. Berkshire Hathaway Inc., A & B 2.8% INSURANCE, U.S. British American Tobacco PLC, ord. & ADR 2.6% TOBACCO, U.K. Microsoft Corp. 2.4% SOFTWARE, U.S. CVS Caremark Corp. 2.3% FOOD & STAPLES RETAILING, U.S. Comcast Corp., A 2.1% MEDIA, U.S. Imperial Tobacco Group PLC 2.0% TOBACCO, U.K. Nestle SA 1.9% FOOD PRODUCTS, SWITZERLAND Schering-Plough Corp. 1.7% PHARMACEUTICALS, U.S. News Corp., A 1.5% MEDIA, U.S.
Semiannual Report | 7 more stable pricing environment in the future. The company also reached an agreement with British Sky Broadcasting Group, the U.K.'s top pay-TV provider, regarding redistribution of content, thereby strengthening Virgin's video offerings. Ofcom, U.K.'s broadcasting and communications regulator, recently issued a report supporting wider access to exclusive content through lower, and potentially regulated, wholesale pricing that could further strengthen Virgin Media's video products. The company's stock received further support after investors began to anticipate that future efficiency gains could result from subscriber growth and pricing improvement, and a more stable competitive market could drive earnings growth in the second half of the year. Microsoft manufactures, licenses and supports a wide range of proprietary software products and services, and is the world's largest software company. Companywide cost controls implemented in late 2008 gained traction and began to benefit operating results in 2009. Microsoft also announced several new products, including a rebranded search engine, Bing, and the next version of the Windows operating system. The combination of cost discipline and new revenue opportunities appeared to revitalize the company and Microsoft's image with investors. Although the Fund outperformed the S&P 500 during the first half of 2009, it had some disappointments. Three investments that declined in value were U.S. Bancorp, a diversified financial services company; Comcast, a cable services provider; and U.K.-based Imperial Tobacco, a leading international tobacco company. U.S. Bancorp reported higher-than-anticipated securities losses and a subsequent 25% decrease in tangible book value in 2009's first quarter. Investor fears about continued deterioration in the value of the company's assets led to further pressure on the shares, as well as those of its peers. We exited the position during the period under review. Comcast shares fell after the company reported a decline in subscriber growth across all products -- video, data and telephony -- when it reported 2008 fourth quarter results. In addition, given the improvement in corporate debt markets during the second quarter and Comcast's relatively underleveraged balance sheet, investors began to anticipate a more significant increase in the dividend and/or an increase in share repurchase activity. The fact that the company undertook neither appeared to create uncertainty and sparked speculation about potential merger and acquisition activity. 8 | Semiannual Report Imperial Tobacco shares declined after investors grew wary about the company's balance sheet and dividend policy, and investors generally rotated away from typically defensive sectors as cyclical stocks rallied strongly during the second quarter. At period-end, we still believed Imperial shares were an attractive investment trading at a single-digit 2010 price-to-earnings multiple and boasting more than 5% in free cash flow yield. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual Shares Fund. We look forward to serving your future investment needs. (PHOTO OF PETER A. LANGERMAN) /s/ Peter A. Langerman Peter A. Langerman Co-Portfolio Manager (PHOTO OF F. DAVID SEGAL) /s/ F. David Segal F. David Segal, CFA Co-Portfolio Manager (PHOTO OF DEBBIE A. TURNER) /s/ Debbie A. Turner Debbie A. Turner, CFA Assistant Portfolio Manager Mutual Shares Fund Semiannual Report | 9 THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. PETER LANGERMAN has been portfolio manager for Mutual Shares Fund since 2005. He joined Franklin Templeton Investments in 1996, serving in various capacities, including President and Chief Executive Officer of Franklin Mutual Advisers and member of the management team of the Funds, including Mutual Shares Fund. From 2002 to 2005, he served as director of New Jersey's Division of Investment, overseeing employee pension funds. Between 1986 and 1996, Mr. Langerman was employed at Heine Securities Corporation, the Fund's former manager. F. DAVID SEGAL has been portfolio manager for Mutual Shares Fund since 2005. He joined Franklin Templeton Investments in 2002. Previously, he was an analyst in the Structured Finance Group of MetLife for the period 1999-2002. DEBBIE TURNER has been assistant portfolio manager for Mutual Shares Fund since 2001. She joined Franklin Templeton Investments in 1996. Between 1993 and 1996, Ms. Turner was employed at Heine Securities Corporation, the Fund's former manager. 10 | Semiannual Report Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: MUTHX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.83 $16.15 $15.32
CLASS A (SYMBOL: TESIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.80 $16.02 $15.22
CLASS B (SYMBOL: FMUBX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.73 $15.67 $14.94
CLASS C (SYMBOL: TEMTX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.74 $15.84 $15.10
CLASS R (SYMBOL: TESRX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.77 $15.92 $15.15
Semiannual Report | 11 Performance Summary (CONTINUED) PERFORMANCE CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z/R: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------- ------- ------- Cumulative Total Return(2) +5.42% -23.55% -2.72% +35.22% Average Annual Total Return(3) +5.42% -23.55% -0.55% +3.06% Value of $10,000 Investment(4) $10,542 $ 7,645 $ 9,728 $13,522 Total Annual Operating Expenses(5) 0.79%
CLASS A(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------- ------- ------- Cumulative Total Return(2) +5.26% -23.79% -4.32% +30.67% Average Annual Total Return(3) -0.80% -28.17% -2.05% +2.11% Value of $10,000 Investment(4) $ 9,920 $ 7,183 $ 9,018 $12,317 Total Annual Operating Expenses(5) 1.08%
CLASS B(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------- ------- ------- Cumulative Total Return(2) +4.89% -24.34% -7.47% +23.99% Average Annual Total Return(3) +0.89% -27.33% -1.86% +2.17% Value of $10,000 Investment(4) $10,089 $ 7,267 $ 9,104 $12,399 Total Annual Operating Expenses(5) 1.79%
CLASS C(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------- ------- ------- Cumulative Total Return(2) +4.90% -24.32% -7.45% +22.38% Average Annual Total Return(3) +3.90% -25.07% -1.54% +2.04% Value of $10,000 Investment(4) $10,390 $ 7,493 $ 9,255 $12,238 Total Annual Operating Expenses(5) 1.77%
INCEPTION CLASS R 6-MONTH 1-YEAR 5-YEAR (1/1/02) - ---------- ------- ------- ------- --------- Cumulative Total Return(2) +5.08% -23.95% -5.14% +9.50% Average Annual Total Return(3) +5.08% -23.95% -1.05% +1.22% Value of $10,000 Investment(4) $10,508 $ 7,605 $ 9,486 $10,950 Total Annual Operating Expenses(5) 1.29%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. 12 | Semiannual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN FOREIGN SECURITIES INVOLVE SPECIAL RISKS INCLUDING CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. CLASS R: Shares are available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. (1.) Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the periods indicated. (3.) Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. Semiannual Report | 13 Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Semiannual Report Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 - ------- ----------------- -------------- ---------------------- Actual $1,000 $1,054.20 $4.58 Hypothetical (5% return before expenses) $1,000 $1,020.33 $4.51 CLASS A Actual $1,000 $1,052.60 $6.11 Hypothetical (5% return before expenses) $1,000 $1,018.84 $6.01 CLASS B Actual $1,000 $1,048.90 $9.65 Hypothetical (5% return before expenses) $1,000 $1,015.37 $9.49 CLASS C Actual $1,000 $1,049.00 $9.65 Hypothetical (5% return before expenses) $1,000 $1,015.37 $9.49 CLASS R Actual $1,000 $1,050.80 $7.12 Hypothetical (5% return before expenses) $1,000 $1,017.85 $7.00
* Expenses are calculated using the most recent six-month expense ratio net of expense waivers, annualized for each class (Z: 0.90%; A: 1.20%; B: 1.90%; C: 1.90%; and R: 1.40%), multiplied by the average account value over the period, multiplied by 181/365 to reflect the one-half year period. Semiannual Report | 15 Mutual Shares Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------------------- CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ----------- ----------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .. $ 15.32 $ 25.33 $ 26.08 $ 23.95 $ 23.05 $ 20.99 ---------- ---------- ----------- ----------- ---------- ---------- Income from investment operations(a): Net investment income(b) ........... 0.13(c) 0.45 0.70 0.42 0.47 0.35 Net realized and unrealized gains (losses) .................. 0.70 (9.99) 0.17 3.90 1.92 2.52 ---------- ---------- ----------- ----------- ---------- ---------- Total from investment operations ...... 0.83 (9.54) 0.87 4.32 2.39 2.87 ---------- ---------- ----------- ----------- ---------- ---------- Less distributions from: Net investment income .............. -- (0.27) (0.75) (0.52) (0.29) (0.39) Net realized gains ................. -- (0.20) (0.87) (1.67) (1.20) (0.42) ---------- ---------- ----------- ----------- ---------- ---------- Total distributions ................... -- (0.47) (1.62) (2.19) (1.49) (0.81) ---------- ---------- ----------- ----------- ---------- ---------- Redemption fees(d) .................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ----------- ----------- ---------- ---------- Net asset value, end of period ........ $ 16.15 $ 15.32 $ 25.33 $ 26.08 $ 23.95 $ 23.05 ========== ========== =========== =========== ========== ========== Total return(f) ....................... 5.42% (37.92)% 3.30% 18.37% 10.39% 13.89% RATIOS TO AVERAGE NET ASSETS(g) Expenses before waiver and payments by affiliates(h, i) ................... 0.91% 0.79% 0.75% 0.84% 0.81% 0.81% Expenses net of waiver and payments by affiliates(h, i) ................... 0.90% 0.79% 0.75% 0.84% 0.81% 0.81% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before waiver and payments by affiliates(i) ................ 0.85% 0.78% 0.74% 0.76% 0.76% 0.80% Expenses net of waiver and payments by affiliates(i) ................ 0.84% 0.78% 0.74% 0.76% 0.76% 0.80% Net investment income ................. 1.72%(c) 2.14% 2.57% 1.63% 1.99% 1.62% SUPPLEMENTAL DATA Net assets, end of period (000's) ..... $7,267,113 $7,236,112 $13,262,561 $11,577,506 $8,951,080 $7,240,641 Portfolio turnover rate ............... 24.43% 37.97% 40.57% 33.40% 21.57% 33.22%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.08) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 2.75%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (i) Benefit of expense reduction rounds to less than 0.01%. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .. $ 15.22 $ 25.14 $ 25.90 $ 23.82 $ 22.94 $ 20.90 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ........... 0.10(c) 0.39 0.61 0.32 0.39 0.27 Net realized and unrealized gains (losses) .................. 0.70 (9.90) 0.17 3.88 1.91 2.51 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ...... 0.80 (9.51) 0.78 4.20 2.30 2.78 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income .............. -- (0.21) (0.67) (0.45) (0.22) (0.32) Net realized gains ................. -- (0.20) (0.87) (1.67) (1.20) (0.42) ---------- ---------- ---------- ---------- ---------- ---------- Total distributions ................... -- (0.41) (1.54) (2.12) (1.42) (0.74) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) .................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ........ $ 16.02 $ 15.22 $ 25.14 $ 25.90 $ 23.82 $ 22.94 ========== ========== ========== ========== ========== ========== Total return(f) ....................... 5.26% (38.10)% 2.97% 17.98% 9.98% 13.50% RATIOS TO AVERAGE NET ASSETS(g) Expenses before waiver and payments by affiliates(h, i) .................. 1.21% 1.08% 1.07% 1.18% 1.16% 1.16% Expenses net of waiver and payments by affiliates(h, i) ................... 1.20% 1.08% 1.07% 1.18% 1.16% 1.16% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before waiver and payments by affiliates(i) ................ 1.15% 1.07% 1.06% 1.10% 1.11% 1.15% Expenses net of waiver and payments by affiliates(i) ................ 1.14% 1.07% 1.06% 1.10% 1.11% 1.15% Net investment income ................. 1.42%(c) 1.85% 2.25% 1.29% 1.64% 1.27% SUPPLEMENTAL DATA Net assets, end of period (000's) ..... $4,387,124 $4,624,696 $8,469,264 $6,761,779 $4,211,238 $2,940,029 Portfolio turnover rate ............... 24.43% 37.97% 40.57% 33.40% 21.57% 33.22%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.08) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 2.45%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (i) Benefit of expense reduction rounds to less than 0.01%. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------- CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- -------- -------- -------- --------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 14.94 $ 24.60 $ 25.35 $ 23.35 $ 22.50 $ 20.54 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.05(c) 0.23 0.41 0.16 0.23 0.13 Net realized and unrealized gains (losses) ........................... 0.68 (9.65) 0.18 3.78 1.88 2.44 -------- -------- -------- -------- -------- -------- Total from investment operations ......... 0.73 (9.42) 0.59 3.94 2.11 2.57 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ................. -- (0.04) (0.47) (0.27) (0.06) (0.19) Net realized gains .................... -- (0.20) (0.87) (1.67) (1.20) (0.42) -------- -------- -------- -------- -------- -------- Total distributions ...................... -- (0.24) (1.34) (1.94) (1.26) (0.61) -------- -------- -------- -------- -------- -------- Redemption fees(d) ....................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- -------- Net asset value, end of period ........... $ 15.67 $ 14.94 $ 24.60 $ 25.35 $ 23.35 $ 22.50 ======== ======== ======== ======== ======== ======== Total return(f) .......................... 4.89% (38.54)% 2.25% 17.21% 9.31% 12.70% RATIOS TO AVERAGE NET ASSETS(g) Expenses before waiver and payments by affiliates(h, i) ...................... 1.91% 1.79% 1.75% 1.84% 1.81% 1.81% Expenses net of waiver and payments by affiliates(h, i) ...................... 1.90% 1.79% 1.75% 1.84% 1.81% 1.81% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before waiver and payments by affiliates(i) ................... 1.85% 1.78% 1.74% 1.76% 1.76% 1.80% Expenses net of waiver and payments by affiliates(i) ................... 1.84% 1.78%(h) 1.74%(h) 1.76%(h) 1.76%(h) 1.80%(h) Net investment income .................... 0.72%(c) 1.14% 1.57% 0.63% 0.99% 0.62% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $240,317 $272,750 $586,289 $659,186 $612,007 $588,401 Portfolio turnover rate .................. 24.43% 37.97% 40.57% 33.40% 21.57% 33.22%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.08) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.75%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (i) Benefit of expense reduction rounds to less than 0.01%. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ----------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 15.10 $ 24.86 $ 25.63 $ 23.48 $ 22.76 $ 20.75 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) .............. 0.05(c) 0.24 0.42 0.16 0.23 0.13 Net realized and unrealized gains (losses) ........................... 0.69 (9.75) 0.17 3.82 1.89 2.49 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ......... 0.74 (9.51) 0.59 3.98 2.12 2.62 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income ................. -- (0.05) (0.49) (0.16) (0.20) (0.19) Net realized gains .................... -- (0.20) (0.87) (1.67) (1.20) (0.42) ---------- ---------- ---------- ---------- ---------- ---------- Total distributions ...................... -- (0.25) (1.36) (1.83) (1.40) (0.61) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) ....................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ........... $ 15.84 $ 15.10 $ 24.86 $ 25.63 $ 23.48 $ 22.76 ========== ========== ========== ========== ========== ========== Total return(f) .......................... 4.90% (38.53)% 2.30% 17.18% 9.27% 12.77% RATIOS TO AVERAGE NET ASSETS(g) Expenses before waiver and payments by affiliates(h, i) ...................... 1.91% 1.77% 1.75% 1.84% 1.81% 1.81% Expenses net of waiver and payments by affiliates(h, i) ...................... 1.90% 1.77% 1.75% 1.84% 1.81% 1.81% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before waiver and payments by affiliates(i) .......... 1.85% 1.76% 1.74% 1.76% 1.76% 1.80% Expenses net of waiver and payments by affiliates(i) .......... 1.84% 1.76% 1.74% 1.76% 1.76% 1.80% Net investment income .................... 0.72%(c) 1.16% 1.57% 0.63% 0.99% 0.62% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $1,202,991 $1,296,171 $2,617,083 $2,387,517 $1,834,009 $1,551,111 Portfolio turnover rate .................. 24.43% 37.97% 40.57% 33.40% 21.57% 33.22%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.08) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.75%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (i) Benefit of expense reduction rounds to less than 0.01%. The accompanying notes are an integral part of these financial statements. Semiannual Report | 19 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------- CLASS R (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- -------- -------- -------- -------- ------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ........... $ 15.15 $ 25.00 $ 25.77 $ 23.72 $ 22.85 $ 20.83 -------- -------- -------- -------- -------- ------- Income from investment operations(a): Net investment income(b) .................... 0.09(c) 0.34 0.55 0.28 0.35 0.24 Net realized and unrealized gains (losses) .. 0.68 (9.83) 0.18 3.86 1.91 2.50 -------- -------- -------- -------- -------- ------- Total from investment operations ............... 0.77 (9.49) 0.73 4.14 2.26 2.74 -------- -------- -------- -------- -------- ------- Less distributions from: Net investment income ....................... -- (0.16) (0.63) (0.42) (0.19) (0.30) Net realized gains .......................... -- (0.20) (0.87) (1.67) (1.20) (0.42) -------- -------- -------- -------- -------- ------- Total distributions ............................ -- (0.36) (1.50) (2.09) (1.39) (0.72) -------- -------- -------- -------- -------- ------- Redemption fees(d) ............................. -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- ------- Net asset value, end of period ................. $ 15.92 $ 15.15 $ 25.00 $ 25.77 $ 23.72 $ 22.85 ======== ======== ======== ======== ======== ======= Total return(f) ................................ 5.08% (38.19)% 2.77% 17.73% 9.88% 13.32% RATIOS TO AVERAGE NET ASSETS(g) Expenses before waiver and payments by affiliates(h, i) ............................ 1.41% 1.29% 1.25% 1.34% 1.31% 1.31% Expenses net of waiver and payments by affiliates(h, i) ............................ 1.40% 1.29% 1.25% 1.34% 1.31% 1.31% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before waiver and payments by affiliates(i) ............................ 1.35% 1.28% 1.24% 1.26% 1.26% 1.30% Expenses net of waiver and payments by affiliates(i) ............................ 1.34% 1.28% 1.24% 1.26% 1.26% 1.30% Net investment income .......................... 1.22%(c) 1.64% 2.07% 1.13% 1.49% 1.12% SUPPLEMENTAL DATA Net assets, end of period (000's) .............. $183,289 $173,496 $297,777 $188,646 $109,305 $74,763 Portfolio turnover rate ........................ 24.43% 37.97% 40.57% 33.40% 21.57% 33.22%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.08) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 2.25%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (i) Benefit of expense reduction rounds to less than 0.01%. The accompanying notes are an integral part of these financial statements. 20 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 86.2% AEROSPACE & DEFENSE 0.9% (a) GenCorp Inc. ............................................. United States 2,073,770 $ 3,960,900 United Technologies Corp. ................................ United States 2,155,580 112,003,937 --------------- 115,964,837 --------------- AIR FREIGHT & LOGISTICS 0.3% TNT NV ................................................... Netherlands 2,255,958 43,808,444 --------------- AIRLINES 0.0%(b) (a) ACE Aviation Holdings Inc., A ............................ Canada 1,263,090 5,756,376 (a, c) Northwest Airlines Corp., Contingent Distribution ........ United States 111,348,000 70,149 --------------- 5,826,525 --------------- AUTO COMPONENTS 0.5% (a, c, d) Collins & Aikman Products Co., Contingent Distribution ... United States 3,845,673 38,457 (a, c, d) Dana Holding Corp., Contingent Distribution .............. United States 45,477,000 -- (a) Goodyear Tire & Rubber Co. ............................... United States 4,294,179 48,352,455 (a, e, f) IACNA Investor LLC ....................................... United States 678,719 6,787 (a, e, f, g) International Automotive Components Group Brazil LLC ..... Brazil 7,234,813 6,478,345 (a, e, f, g) International Automotive Components Group Japan LLC ...... Japan 1,104,272 3,054,740 (a, e, f, g) International Automotive Components Group LLC ............ Luxembourg 25,796,752 5,853,283 (a, e, f, g) International Automotive Components Group NA LLC, A ...... United States 19,434,979 740,473 --------------- 64,524,540 --------------- AUTOMOBILES 0.4% Daimler AG ............................................... Germany 1,413,460 50,990,392 --------------- BEVERAGES 4.3% Brown-Forman Corp., A .................................... United States 125,460 5,784,960 Brown-Forman Corp., B .................................... United States 788,910 33,907,352 Carlsberg AS, B .......................................... Denmark 984,186 63,116,175 (a) Dr. Pepper Snapple Group Inc.............................. United States 7,988,898 169,284,749 Lion Nathan Ltd. ......................................... Australia 2,494,675 23,242,244 Pepsi Bottling Group Inc. ................................ United States 3,036,499 102,755,126 PepsiAmericas Inc. ....................................... United States 917,700 24,603,537 Pernod Ricard SA ......................................... France 2,426,861 152,733,686 --------------- 575,427,829 --------------- BUILDING PRODUCTS 0.3% (a) Owens Corning Inc......................................... United States 3,320,705 42,438,610 --------------- CAPITAL MARKETS 0.2% Ameriprise Financial Inc.................................. United States 1,064,600 25,837,842 --------------- CHEMICALS 1.6% (a, c, d) Dow Corning Corp., Contingent Distribution ............... United States 21,830,547 3,157,637 Koninklijke DSM NV ....................................... Netherlands 2,344,242 73,421,800 Linde AG ................................................. Germany 1,730,358 141,809,626 --------------- 218,389,063 ---------------
Semiannual Report | 21 Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL BANKS 1.0% Barclays PLC ............................................. United Kingdom 14,293,167 $ 66,553,855 (a, e, f) Elephant Capital Holdings Ltd. ........................... Japan 64,834 -- (a, f) Guaranty Bancorp ......................................... United States 5,731,834 10,947,803 (a) Intesa Sanpaolo SpA ...................................... Italy 15,273,862 49,166,060 (a, e) NCB Warrant Holdings Ltd., A ............................. Japan 301,530 -- --------------- 126,667,718 --------------- COMMERCIAL SERVICES & SUPPLIES 0.0%(b) (a) Comdisco Holding Co. Inc. ................................ United States 2,122 15,491 (a, c) Comdisco Holding Co. Inc., Contingent Distribution ....... United States 86,205,000 -- --------------- 15,491 --------------- COMMUNICATIONS EQUIPMENT 0.9% Motorola Inc. ............................................ United States 18,235,530 120,901,564 --------------- COMPUTERS & PERIPHERALS 2.0% (a, e, f) DecisionOne Corp. ........................................ United States 1,879,100 3,100,515 (a, e, f) DecisionOne Corp., wts., 6/08/17 ......................... United States 1,031,766 -- (a) Dell Inc. ................................................ United States 13,795,240 189,408,645 (a) Sun Microsystems Inc. .................................... United States 7,297,180 67,280,000 --------------- 259,789,160 --------------- CONSUMER FINANCE 1.0% (a, e, f, g) CB FIM Coinvestors LLC ................................... United States 43,105,703 98,418,941 (a, e) Cerberus CG Investor I LLC ............................... United States 56,116,385 10,662,113 (a, e) Cerberus CG Investor II LLC .............................. United States 56,116,385 10,662,113 (a, e) Cerberus CG Investor III LLC ............................. United States 28,058,192 5,331,056 (a, e) Cerberus FIM Investors Holdco LLC ........................ United States 53,924,666 3,925,716 --------------- 128,999,939 --------------- CONTAINERS & PACKAGING 0.4% Temple-Inland Inc. ....................................... United States 4,050,120 53,137,574 --------------- DIVERSIFIED CONSUMER SERVICES 0.4% H&R Block Inc. ........................................... United States 2,062,540 35,537,564 Hillenbrand Inc. ......................................... United States 1,462,406 24,334,436 --------------- 59,872,000 --------------- DIVERSIFIED FINANCIAL SERVICES 0.7% Bank of America Corp. .................................... United States 2,671,700 35,266,440 Deutsche Boerse AG ....................................... Germany 785,973 60,940,992 (a, e, f) GLCP Harrah's Investment LP .............................. United States 22,185,100 -- (a, c) Marconi Corp., Contingent Distribution ................... United Kingdom 77,739,439 -- --------------- 96,207,432 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.4% (a, e, f) AboveNet Inc. ............................................ United States 842,420 68,219,172 (a, e, f) AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ............................... United States 1,065 63,932 (a, e, f) AboveNet Inc., wts., 9/08/10 ............................. United States 34,449 1,980,817 (a, c, d) Global Crossing Holdings Ltd., Contingent Distribution ... United States 105,649,309 --
22 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED TELECOMMUNICATION SERVICES (CONTINUED) Koninklijke KPN NV ....................................... Netherlands 12,415,256 $ 170,636,250 Qwest Communications International Inc. .................. United States 24,047,649 99,797,743 Telefonica SA ............................................ Spain 5,098,560 115,278,000 --------------- 455,975,914 --------------- ELECTRIC UTILITIES 2.7% E.ON AG .................................................. Germany 5,251,033 185,821,456 Entergy Corp. ............................................ United States 821,510 63,683,455 Exelon Corp. ............................................. United States 2,046,010 104,776,172 --------------- 354,281,083 --------------- ELECTRONIC EQUIPMENT, INSTRUMENTS & COMPONENT 0.7% Tyco Electronics Ltd...................................... United States 5,025,352 93,421,294 --------------- ENERGY EQUIPMENT & SERVICES 2.1% Baker Hughes Inc. ........................................ United States 1,006,840 36,689,249 (a) Exterran Holding Inc. .................................... United States 2,387,650 38,297,906 (a) Pride International Inc. ................................. United States 1,850,030 46,361,752 (a) Transocean Ltd. .......................................... United States 2,125,292 157,887,943 --------------- 279,236,850 --------------- FOOD & STAPLES RETAILING 5.3% Carrefour SA ............................................. France 3,128,369 133,478,416 CVS Caremark Corp. ....................................... United States 9,570,979 305,027,101 Kroger Co. ............................................... United States 6,237,368 137,533,964 SUPERVALU Inc. ........................................... United States 3,873,943 50,167,562 Wal-Mart Stores Inc. ..................................... United States 1,504,460 72,876,042 --------------- 699,083,085 --------------- FOOD PRODUCTS 5.3% Cadbury PLC .............................................. United Kingdom 12,897,968 109,928,263 Danone ................................................... France 1,720,750 84,907,778 General Mills Inc. ....................................... United States 1,515,370 84,891,027 Kraft Foods Inc., A ...................................... United States 7,077,922 179,354,544 Nestle SA ................................................ Switzerland 6,531,700 245,907,778 --------------- 704,989,390 --------------- HEALTH CARE PROVIDERS & SERVICES 1.6% (a, f) Community Health Systems Inc. ............................ United States 4,806,000 121,351,500 (a) Kindred Healthcare Inc. .................................. United States 1,441,599 17,832,580 (a, f) Tenet Healthcare Corp. ................................... United States 25,881,411 72,985,579 --------------- 212,169,659 --------------- HOTELS, RESTAURANTS & LEISURE 0.0%(b) (a) Trump Entertainment Resorts Inc. ......................... United States 832,967 141,604 --------------- INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 1.0% Constellation Energy Group ............................... United States 4,129,397 109,759,372 (a) NRG Energy Inc............................................ United States 988,037 25,649,441 --------------- 135,408,813 ---------------
Semiannual Report | 23 Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INDUSTRIAL CONGLOMERATES 4.3% Keppel Corp. Ltd. ........................................ Singapore 16,278,934 $ 77,534,786 Koninklijke Philips Electronics NV ....................... Netherlands 4,479,993 82,472,756 (g) Orkla ASA ................................................ Norway 24,350,543 176,774,139 Siemens AG ............................................... Germany 2,072,525 143,107,856 Tyco International Ltd. .................................. United States 3,657,657 95,025,929 --------------- 574,915,466 --------------- INSURANCE 7.0% ACE Ltd. ................................................. United States 2,345,100 103,723,773 (a) Alleghany Corp. .......................................... United States 362,736 98,301,456 (a) Berkshire Hathaway Inc., A ............................... United States 1,590 143,100,000 (a) Berkshire Hathaway Inc., B ............................... United States 80,163 232,130,404 (a) Conseco Inc. ............................................. United States 4,553,790 10,792,482 Old Republic International Corp. ......................... United States 6,101,302 60,097,825 (a, e) Olympus Re Holdings Ltd. ................................. United States 202,380 442,281 The Travelers Cos. Inc. .................................. United States 1,385,982 56,880,701 (f) White Mountains Insurance Group Ltd. ..................... United States 729,457 166,980,002 Zurich Financial Services AG ............................. Switzerland 352,340 62,046,073 --------------- 934,494,997 --------------- LEISURE EQUIPMENT & PRODUCTS 1.7% Eastman Kodak Co.......................................... United States 8,494,150 25,142,684 Mattel Inc ............................................... United States 12,221,760 196,159,248 --------------- 221,301,932 --------------- LIFE SCIENCES TOOLS & SERVICES 0.7% (a) MDS Inc. ................................................. Canada 3,411,468 17,923,444 (a) Thermo Fisher Scientific Inc.............................. United States 1,771,650 72,230,171 --------------- 90,153,615 --------------- MACHINERY 1.0% AB SKF, B ................................................ Sweden 4,550,800 56,026,904 (f) Federal Signal Corp. ..................................... United States 3,360,800 25,710,120 (a, e, f, g) Motor Coach Industries International Inc. ................ United States 11,211 14,579,905 Parker Hannifin Corp. .................................... United States 848,060 36,432,658 --------------- 132,749,587 --------------- MARINE 0.7% A.P. Moller - Maersk AS .................................. Denmark 15,130 90,617,572 --------------- MEDIA 5.0% (a) Adelphia Recovery Trust .................................. United States 99,967,609 2,499,190 (a, c) Adelphia Recovery Trust, Arahova Contingent Value Vehicle, Contingent Distribution ............................... United States 12,005,115 2,280,972 (a, c) Century Communications Corp., Contingent Distribution .... United States 33,138,000 -- Comcast Corp., A ......................................... United States 19,942,140 281,184,174 News Corp., A ............................................ United States 22,460,462 204,614,809 Time Warner Cable Inc. ................................... United States 1,267,452 40,140,205 (a, d, f) TVMAX Holdings Inc. ...................................... United States 257,217 -- Virgin Media Inc. ........................................ United Kingdom 14,209,364 132,857,553 --------------- 663,576,903 ---------------
24 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) METALS & MINING 0.6% Anglo American PLC ....................................... United Kingdom 2,929,898 $ 85,013,183 --------------- MULTI-UTILITIES 0.5% GDF Suez ................................................. France 1,830,119 68,126,191 (a, c) NorthWestern Corp., Contingent Distribution .............. United States 21,590,000 -- --------------- 68,126,191 --------------- OIL, GAS & CONSUMABLE FUELS 3.8% (a, d) Apco Oil Corp., Liquidating Trust ........................ United States 9,200 -- BP PLC ................................................... United Kingdom 8,753,009 68,811,628 BP PLC, ADR .............................................. United Kingdom 46,400 2,212,352 Marathon Oil Corp. ....................................... United States 5,387,400 162,322,362 Noble Energy Inc. ........................................ United States 596,875 35,197,718 Royal Dutch Shell PLC, A ................................. United Kingdom 5,993,596 149,637,805 Total SA, B .............................................. France 1,523,752 82,240,021 --------------- 500,421,886 --------------- PAPER & FOREST PRODUCTS 3.2% (a) Domtar Corp. ............................................. United States 1,336,484 22,158,905 International Paper Co. .................................. United States 9,480,806 143,444,595 MeadWestvaco Corp. ....................................... United States 4,116,457 67,551,059 Weyerhaeuser Co. ......................................... United States 6,165,330 187,610,992 --------------- 420,765,551 --------------- PHARMACEUTICALS 5.7% Novartis AG .............................................. Switzerland 2,427,900 98,375,854 Schering-Plough Corp. .................................... United States 9,213,815 231,451,033 (a) Valeant Pharmaceuticals International .................... United States 1,501,127 38,608,987 Wyeth .................................................... United States 8,488,690 385,301,639 --------------- 753,737,513 --------------- REAL ESTATE INVESTMENT TRUSTS (REITS) 1.5% (f) Alexander's Inc. ......................................... United States 326,675 88,071,580 Link REIT ................................................ Hong Kong 26,757,775 57,107,008 Ventas Inc................................................ United States 1,072,765 32,032,763 Vornado Realty Trust ..................................... United States 612,500 27,580,875 --------------- 204,792,226 --------------- REAL ESTATE MANAGEMENT & DEVELOPMENT 0.7% (a, d) Canary Wharf Group PLC ................................... United Kingdom 14,262,931 41,068,150 (a) Forestar Real Estate Group ............................... United States 1,473,566 17,505,964 (a) The St. Joe Co............................................ United States 1,100,535 29,153,172 --------------- 87,727,286 --------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 1.5% (a) LSI Corp. ................................................ United States 24,355,334 111,060,323 Maxim Integrated Products Inc. ........................... United States 5,769,500 90,523,455 --------------- 201,583,778 --------------- SOFTWARE 2.4% (h) Microsoft Corp............................................ United States 13,248,800 314,923,976 ---------------
Semiannual Report | 25 Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 8.9% Altria Group Inc. ........................................ United States 11,174,504 $ 183,150,121 British American Tobacco PLC ............................. United Kingdom 12,181,486 335,316,190 British American Tobacco, PLC, ADR ....................... United Kingdom 70,550 3,936,690 Imperial Tobacco Group PLC ............................... United Kingdom 10,399,933 270,019,949 Japan Tobacco Inc. ....................................... Japan 30,953 97,009,195 KT&G Corp. ............................................... South Korea 1,372,638 77,525,836 Lorillard Inc. ........................................... United States 545,400 36,961,758 Philip Morris International Inc. ......................... United States 1,599,950 69,789,819 Reynolds American Inc. ................................... United States 2,793,900 107,900,418 --------------- 1,181,609,976 --------------- TRANSPORTATION INFRASTRUCTURE 0.0%(b) (a) Groupe Eurotunnel SA ..................................... France 30,676 173,826 (a) Groupe Eurotunnel SA, wts., 12/30/11 ..................... France 2,855,237 452,537 --------------- 626,363 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $13,680,925,089) ................................ 11,450,644,653 --------------- PREFERRED STOCKS 0.6% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(b) (a, e) PTV Inc., 10.00%, pfd., A ................................ United Kingdom 199,566 47,896 --------------- MACHINERY 0.6% (a, e, f, g) Motor Coach Industries International Inc., pfd. .......... United States 80,429 80,429,000 --------------- TOTAL PREFERRED STOCKS (COST $80,554,727) ................ 80,476,896 --------------- OPTIONS PURCHASED (COST $45,653,802) 0.2% PUT OPTIONS 0.2% (a) S&P 500 Index, exercise price $775, expiration date 12/19/09, contracts ................................... United States 7,734 20,108,400 ---------------
PRINCIPAL AMOUNT(j) ----------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS 4.1% American General Finance Corp., 5.85%, 6/01/13 ........................................ United States 4,180,000 2,400,378 senior note, J, 6.90%, 12/15/17 ....................... United States 58,420,000 31,675,032 (j) Boston Generating LLC, FRN, Revolver, 1.095%, 12/21/13 ............................ United States 750,254 546,748 Synthetic Letter of Credit, 1.095%, 12/21/13 .......... United States 2,679,425 1,952,631 Term Loan B, 2.569%, 12/21/13 ......................... United States 11,808,412 8,605,380 (j) Calpine Corp., Exit Term Loan, FRN, 4.095%, 3/29/14 ...... United States 161,466,665 143,346,553 (e, k) Cerberus CG Investor I LLC, 12.00%, 7/31/14 .............. United States 49,252,400 9,357,956 (e, k) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............. United States 49,252,400 9,357,956 (e, k) Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............ United States 24,626,200 4,678,978 (e, k) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ...... United States 159,591,548 11,610,445 (f) DecisionOne Corp., (e) senior secured note, 15.00%, 11/30/13 ................ United States 2,467,888 2,755,397 (d) Term Loan B, 15.0.% 8/29/13 .......................... United States 433,342 483,826
26 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(I) VALUE -------------- ----------- --------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS (CONTINUED) Exterran Holding Inc., senior note, cvt., 4.25%, 6/15/14 ............................................... United States 15,483,000 $ 14,457,251 (j) First Data Corp., Term LoanFRN, 3.065%, 9/24/14, B-1 ................................................... United States 22,832,605 17,168,841 B-2 ................................................... United States 22,531,305 16,954,807 B-3 ................................................... United States 5,645,703 4,243,101 Groupe Eurotunnel SA, cvt., sub. bond, NRS I, T2, 3.00%, 7/28/09 .................................... France 53,400 EUR 59,919 T2, 3.00%, 7/28/09 .................................... France 43,989 GBP 75,996 T3, 3.00%, 7/28/10 .................................... France 18,944,500 EUR 21,257,246 T3, 3.00%, 7/28/10 .................................... France 11,239,769 GBP 19,418,023 (d, f, g, j) International Automotive Components Group NA Inc., Revolver, FRN, 5.75%, 1/18/14 ......................... United States 3,854,095 3,854,095 (e, f, g, k) International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............................................... United States 5,851,000 2,654,791 (e, g, j, l) Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 .... United States 72,804,274 69,859,566 (e, g, j, l) Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ................................... United States 11,547,071 20,115,930 (j) Realogy Corp., FRN, Delayed Draw Term B Loan, 4.177%, 10/10/13 ............ United States 2,838,588 2,070,142 Initial Term Loan B, 4.177%, 10/10/13 ................. United States 23,291,001 16,985,801 (m) Revolver, 3.427%, 4/10/13 ............................ United States 37,151,765 23,962,888 Synthetic Letter of Credit, 0.185%, 10/10/13 .......... United States 6,270,636 4,573,087 (j) Texas Competitive Electric Holdings Co. LLC, FRN, Initial Tranche B-1 Term Loan, 3.821%, 10/10/14 ....... United States 72,241,538 51,682,824 Term Loan B3, 3.821%, 10/10/14 ........................ United States 33,238,239 23,827,662 Tranche B-2 Term Loan, 3.821%, 10/10/14 ............... United States 11,247,739 8,065,338 (d, f, n) TVMAX Holdings Inc., PIK, 11.50%, 9/30/09 ....................................... United States 1,203,857 338,050 14.00%, 9/30/09 ....................................... United States 1,972,290 532,737 --------------- TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS (COST $891,975,746) ......................... 548,929,375 --------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS IN REORGANIZATION 1.2% (j, k) Charter Communications Operating LLC, FRN, Incremental Term Loan, 9.25%, 3/06/14 ................. United States 16,735,991 16,495,411 Term Loan B, 6.25%, 3/06/14 ........................... United States 97,640,635 88,547,851 (j, k) Quebecor World Inc., DIP Term Loan, FRN, 8.25%, 7/21/09 .. Canada 27,618,932 26,859,412 (d, k) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 .. United States 85,000 425 (j, k, o) Spectrum Brands Inc., FRN, Dollar Term Loan B, 8.00%, 4/01/13 .................... United States 3,300,287 2,959,258 Euro Term Loan, 5.41%, 4/01/13 ........................ United States 10,380,710 EUR 12,703,587 Letter of Credit Commitment, 6.25%, 4/01/13 ........... United States 168,642 151,216 (k) Trump Entertainment Resorts Inc., 8.50%, 6/01/15 ......... United States 36,590,212 4,710,990 (g, k) Wimar OPCO LLC/Finance Corp., senior sub. note, 9.625%, 12/15/14 .............................................. United States 76,355,000 1,049,881 --------------- TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS IN REORGANIZATION (COST $207,096,743) ....... 153,478,031 ---------------
Semiannual Report | 27 Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(i) VALUE -------------- ----------- --------------- COMPANIES IN LIQUIDATION 0.0% (d) Peregrine Investments Holdings Ltd., 6.70%, 1/15/98 ........................................ Hong Kong 95,000,000 JPY $ -- 6.70%, 6/30/00 ........................................ Hong Kong 250,000,000 JPY -- zero cpn., 1/22/98 .................................... Hong Kong 500,000 -- (d) PIV Investment Finance (Cayman) Ltd., 4.50%, 12/01/00 .... Hong Kong 22,710,000 -- --------------- TOTAL COMPANIES IN LIQUIDATION (COST $--) ................ -- --------------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $14,906,206,107) ................................ 12,253,637,355 --------------- SHORT TERM INVESTMENTS 9.5% U.S. GOVERNMENT AND AGENCY SECURITIES 9.5% (p) FHLB, 7/01/09 - 10/15/09 ................................. United States 406,000,000 405,943,687 (p, q) U.S. Treasury Bills, 7/02/09 - 12/24/09 .................. United States 850,000,000 849,571,215 --------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $1,253,764,803) ................................. 1,255,514,902 --------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $16,159,970,910) ................................ 13,509,152,257 ---------------
SHARES ----------- MONEY MARKET FUNDS (COST $131,828) 0.0%(b) (r) Bank of New York Institutional Cash Reserve Fund, 0.12% .. United States 131,828 130,510 --------------- TOTAL INVESTMENTS (COST $16,160,102,738) 101.7% ................................................ 13,509,282,767 OPTIONS WRITTEN (0.0)%(b) ................................ (2,609,856) SECURITIES SOLD SHORT (1.7)% ............................. (227,433,112) OTHER ASSETS, LESS LIABILITIES 0.0%(b) ................... 1,593,281 --------------- NET ASSETS 100.0% ........................................ $13,280,833,080 ===============
CONTRACTS ----------- (s) OPTIONS WRITTEN (PREMIUMS RECEIVED $1,010,789) 0.0%(b) CALL OPTIONS 0.0%(b) SOFTWARE 0.0%(b) Microsoft Corp., Jul. 22 Calls, 7/18/09 .................. United States 13,248 $ 2,609,856 ---------------
SHARES ----------- (t) SECURITIES SOLD SHORT 1.7% PHARMACEUTICALS 1.7% Merck & Co. Inc. ......................................... United States 5,313,607 $ 148,568,452 Pfizer Inc................................................ United States 5,257,644 78,864,660 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $210,614,824) ............................... $ 227,433,112 ---------------
28 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED) (a) Non-income producing. (b) Rounds to less than 0.1% of net assets. (c) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (d) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the aggregate value of these securities was $49,473,377, representing 0.37% of net assets. (e) See Note 9 regarding restricted securities. (f) See Note 13 regarding holdings of 5% voting securities. (g) See Note 14 regarding other considerations. (h) A portion or all of the security is held in connection with written option contracts open at period end. (i) The principal amount is stated in U.S. dollars unless otherwise indicated. (j) The coupon rate shown represents the rate at period end. (k) See Note 8 regarding credit risk and defaulted securities. (l) See Note 1(g) regarding special purpose entities. (m) See Note 10 regarding unfunded loan commitments. (n) Income may be received in additional securities and/or cash. (o) Security purchased on a delayed delivery basis. See Note 1(c). (p) The security is traded on a discount basis with no stated coupon rate. (q) Security or a portion of the security has been segregated as collateral for securities sold short. At June 30, 2009, the value of securities and/or cash pledged amounted to $356,880,063. (r) The rate shown is the annualized seven-day yield at period end. (s) See Note 1(d) regarding written options. (t) See Note 1(f) regarding securities sold short. At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(d).
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION -------- ------------ ---- -------------- --------------- ---------- ------------ ------------- South Korean Won BANT Sell 55,054,243,575 $ 41,896,482 7/08/09 $ -- $ (1,311,783) South Korean Won BBU Sell 6,956,250,000 5,250,000 7/08/09 -- (209,479) South Korean Won BANT Buy 3,800,000,000 2,975,724 7/08/09 6,633 -- British Pound SSBT Sell 81,939,790 122,974,912 7/13/09 -- (11,842,651) British Pound BANT Sell 17,150,000 24,541,695 7/13/09 -- (3,675,624) British Pound HSBC Sell 16,280,000 24,587,428 7/13/09 -- (2,198,459) British Pound BBU Sell 2,610,000 3,947,495 7/13/09 -- (346,803) British Pound DBFX Sell 2,720,000 4,368,456 7/13/09 -- (106,827) British Pound SSBT Buy 2,000,000 2,838,360 7/13/09 452,289 -- British Pound BANT Buy 12,675,000 18,083,642 7/13/09 2,770,849 -- Norwegian Krone BANT Sell 638,366,284 90,831,856 7/13/09 -- (8,366,965) Norwegian Krone HAND Sell 361,000,000 51,102,743 7/13/09 -- (4,994,790) Euro BBU Sell 112,750,000 145,785,750 7/27/09 -- (12,360,045) Euro BANT Sell 108,610,000 140,701,590 7/27/09 -- (11,637,344) Euro HSBC Sell 36,390,812 50,037,860 7/27/09 -- (1,004,747) Euro DBFX Sell 26,190,000 35,890,033 7/27/09 -- (844,676) Swiss Franc BANT Sell 101,368,207 87,664,064 8/10/09 -- (5,650,517) Swiss Franc SSBT Sell 67,460,000 57,800,867 8/10/09 -- (4,299,488)
Semiannual Report | 29 Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------------- --------------- ---------- ------------ ------------- Swiss Franc......... HSBC Sell 74,463,827 $ 64,304,910 8/10/09 $ -- $ (4,242,824) Swiss Franc......... HAND Sell 1,880,902 1,690,000 8/10/09 -- (41,466) Swiss Franc......... DBFX Sell 1,319,710 1,190,000 8/10/09 -- (24,860) Swiss Franc......... BBU Sell 1,318,318 1,190,000 8/10/09 -- (23,578) British Pound....... BBU Sell 106,050,000 159,674,713 8/12/09 -- (14,804,119) British Pound....... DBFX Sell 31,657,593 51,532,230 8/12/09 -- (552,446) Euro................ BANT Sell 93,260,000 120,752,684 8/13/09 -- (10,051,264) Euro................ SSBT Sell 80,914,250 109,500,827 8/13/09 -- (3,987,308) Euro................ BBU Sell 13,400,000 17,891,948 8/13/09 -- (902,529) Euro................ HSBC Sell 3,923,507 5,475,057 8/13/09 -- (27,947) Norwegian Krone..... HAND Sell 20,200,000 3,100,918 8/19/09 -- (35,033) Norwegian Krone..... HAND Buy 24,286,430 3,700,000 8/19/09 70,350 -- Norwegian Krone..... BBU Sell 34,785,650 5,410,000 8/19/09 9,698 -- Norwegian Krone..... DBFX Sell 52,463,286 8,280,000 8/19/09 135,331 -- Canadian Dollar..... SSBT Sell 14,540,457 11,726,175 8/31/09 -- (781,665) Canadian Dollar..... BANT Sell 1,890,000 1,512,423 8/31/09 -- (113,373) Canadian Dollar..... SSBT Buy 9,760,661 8,279,386 8/31/09 116,828 -- Euro................ BANT Sell 52,227,501 69,744,924 8/31/09 -- (3,504,046) Euro................ SSBT Sell 24,454,000 31,373,928 8/31/09 -- (2,922,761) Euro................ HSBC Sell 5,740,000 7,784,162 8/31/09 -- (266,177) Euro................ BBU Sell 18,345,000 25,845,697 8/31/09 116,870 -- Euro................ DBFX Sell 7,080,000 10,128,294 8/31/09 198,608 -- British Pound....... SSBT Sell 141,900,000 200,130,084 9/10/09 -- (33,316,397) British Pound....... BBU Sell 159,579,189 236,655,937 9/14/09 -- (25,872,803) British Pound....... SSBT Sell 1,950,000 2,898,626 9/14/09 -- (309,380) British Pound....... SSBT Buy 3,900,484 6,420,892 9/14/09 -- (4,082) British Pound....... AESX Buy 4,800,000 7,820,798 9/14/09 75,833 -- Euro................ BANT Sell 206,650,000 264,237,237 9/14/09 -- (25,568,640) Euro................ BBU Sell 60,000,000 81,656,100 9/14/09 -- (2,487,876) Euro................ HSBC Sell 2,830,000 3,647,304 9/14/09 -- (321,487) Euro................ SSBT Sell 1,710,000 2,198,068 9/14/09 -- (200,035) Swedish Krona....... HAND Sell 404,658,379 47,178,190 9/16/09 -- (5,254,914) Swedish Krona....... SSBT Buy 1,600,000 192,493 9/16/09 14,825 -- Swedish Krona....... HAND Buy 23,580,008 2,985,000 9/16/09 70,350 -- Australian Dollar... HSBC Sell 6,613,410 5,089,949 9/17/09 -- (203,599) Australian Dollar... SSBT Sell 14,531,008 11,561,988 9/17/09 -- (69,014) Australian Dollar... BANT Sell 6,118,447 4,836,206 9/17/09 -- (63,535) Australian Dollar... SSBT Buy 109,400 87,069 9/17/09 497 -- Singapore Dollar.... SSBT Sell 37,971,851 25,047,709 9/24/09 -- (1,149,953) Singapore Dollar.... BANT Sell 13,625,819 9,141,855 9/24/09 -- (258,914) Singapore Dollar.... HSBC Sell 6,976,249 4,736,230 9/24/09 -- (76,846) Singapore Dollar.... SSBT Buy 3,418,576 2,332,226 9/24/09 26,330 -- Singapore Dollar.... BBU Sell 4,140,720 2,880,000 9/24/09 23,221 -- Euro................ BBU Sell 60,000,000 81,643,200 10/13/09 -- (2,493,672) Japanese Yen........ SSBT Sell 5,245,871,792 53,106,849 10/20/09 -- (1,414,190) Japanese Yen........ BBU Sell 249,635,840 2,560,000 10/20/09 -- (34,498) Japanese Yen........ HSBC Sell 512,304,500 5,310,000 10/20/09 -- (14,448) Japanese Yen........ BANT Buy 123,825,000 1,250,000 10/20/09 36,930 --
30 | Semiannual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------------- --------------- ---------- ------------ ------------- Japanese Yen........ BANT Sell 126,106,200 $ 1,320,000 10/20/09 $ 9,362 $ -- Japanese Yen........ DBFX Sell 236,837,500 2,500,000 10/20/09 38,517 -- Japanese Yen........ AESX Sell 491,243,126 5,120,000 10/20/09 14,445 -- Danish Krone........ HAND Sell 259,352,666 45,142,060 10/23/09 -- (3,621,974) Danish Krone........ BANT Sell 48,625,274 8,605,575 10/23/09 -- (537,051) Danish Krone........ BBU Sell 20,385,083 3,720,000 10/23/09 -- (112,846) Danish Krone........ SSBT Sell 1,861,000 335,280 10/23/09 -- (14,629) Danish Krone........ BBU Buy 6,769,920 1,280,000 10/23/09 -- (7,105) Danish Krone........ SSBT Buy 11,600,000 2,011,793 10/23/09 169,263 -- Danish Krone........ HAND Buy 7,787,557 1,310,000 10/23/09 154,233 -- Euro................ BANT Sell 92,020,000 118,521,760 11/13/09 -- (10,512,369) Euro................ HSBC Sell 6,840,000 9,172,683 11/13/09 -- (418,639) Euro................ BBU Sell 120,000,000 166,752,000 11/30/09 -- (1,514,092) Euro................ BONY Sell 28,443,000 39,481,728 11/30/09 -- (401,542) ---------- ------------- Unrealized appreciation (depreciation)................................................ 4,511,262 (227,386,124) ---------- ------------- Net unrealized appreciation (depreciation)......................................... $(222,874,862) =============
See Abbreviations on page 54. The accompanying notes are an integral part of these financial statements. Semiannual Report | 31 Mutual Shares Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers ................................... $15,269,391,711 Cost - Controlled affiliated issuers (Note 13) ................ 136,442,041 Cost - Non-controlled affiliated issuers (Note 13) ............ 754,268,986 --------------- Total cost of investments ..................................... $16,160,102,738 =============== Value - Unaffiliated issuers .................................. $12,729,691,377 Value - Controlled affiliated issuers (Note 13) ............... 193,427,846 Value - Non-controlled affiliated issuers (Note 13) ........... 586,163,544 --------------- Total value of investments .................................... 13,509,282,767 Cash ............................................................. 3,567,277 Cash on deposit with brokers ..................................... 228,969,880 Foreign currency, at value (cost $4,139,933) ..................... 4,144,667 Receivables: Investment securities sold .................................... 30,820,787 Capital shares sold ........................................... 7,483,688 Dividends and interest ........................................ 24,899,688 Unrealized appreciation on forward exchange contracts ............ 4,511,262 Other assets ..................................................... 19,138 --------------- Total assets ............................................... 13,813,699,154 --------------- Liabilities: Payables: Investment securities purchased ............................... 39,868,350 Capital shares redeemed ....................................... 15,350,994 Affiliates .................................................... 13,013,002 Options written, at value (premiums received $1,010,789) ......... 2,609,856 Securities sold short, at value (proceeds $210,614,824) .......... 227,433,112 Unrealized depreciation on forward exchange contracts ............ 227,386,124 Unrealized depreciation on unfunded loan commitments (Note 10) ... 1,079,076 Accrued expenses and other liabilities ........................... 6,125,560 --------------- Total liabilities .......................................... 532,866,074 --------------- Net assets, at value .................................... $13,280,833,080 =============== Net assets consist of: Paid-in capital .................................................. $17,860,947,214 Undistributed net investment in come ............................. 278,740,559 Net unrealized appreciation (depreciation) ....................... (2,893,643,790) Accumulated net realized gain (loss) ............................. (1,965,210,903) --------------- Net assets, at value ....................................... $13,280,833,080 ===============
The accompanying notes are an integral part of these financial statements. 32 | Semiannual Report Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ................................................... $7,267,112,793 -------------- Shares outstanding ..................................................... 450,010,447 -------------- Net asset value and maximum offering price per share ................... $ 16.15 -------------- CLASS A: Net assets, at value ................................................... $4,387,123,683 -------------- Shares outstanding ..................................................... 273,860,002 -------------- Net asset value per share(a) ........................................... $ 16.02 -------------- Maximum offering price per share (net asset value per share / 94.25%) .. $ 17.00 -------------- CLASS B: Net assets, at value ................................................... $ 240,316,764 -------------- Shares outstanding ..................................................... 15,334,294 -------------- Net asset value and maximum offering price per share(a) ................ $ 15.67 -------------- CLASS C: Net assets, at value ................................................... $1,202,990,896 -------------- Shares outstanding ..................................................... 75,954,734 -------------- Net asset value and maximum offering price per share(a) ................ $ 15.84 -------------- CLASS R: Net assets, at value ................................................... $ 183,288,944 -------------- Shares outstanding ..................................................... 11,509,719 -------------- Net asset value and maximum offering price per share ................... $ 15.92 --------------
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. Semiannual Report | 33 Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends: (net of foreign taxes of $11,707,911) Unaffiliated issuers ............................................................. $ 179,075,170 Non-controlled affiliated issuers (Note 13) ...................................... 1,132,753 Interest: Unaffiliated issuers ............................................................. 47,313,663 Reserve for uncollectible interest (Note 8) ...................................... (64,185,406) Non-controlled affiliated issuers (Note 13) ...................................... 420,814 Income from securities loaned ....................................................... 26,396 --------------- Total investment income ....................................................... 163,783,390 --------------- Expenses: Management fees (Note 3a) ........................................................... 36,058,727 Administrative fees (Note 3b) ....................................................... 4,778,842 Distribution fees: (Note 3c) Class A .......................................................................... 6,243,722 Class B .......................................................................... 1,191,783 Class C .......................................................................... 5,743,828 Class R .......................................................................... 415,652 Transfer agent fees (Note 3e and 3f) ................................................ 9,262,940 Custodian fees (Note 4) ............................................................. 575,689 Reports to shareholders ............................................................. 551,035 Registration and filing fees ........................................................ 257,876 Professional fees ................................................................... 1,203,065 Trustees' fees and expenses ......................................................... 241,133 Dividends on securities sold short .................................................. 3,867,843 Other ............................................................................... 290,113 --------------- Total expenses ................................................................ 70,682,248 --------------- Expense reductions (Note 4) ................................................... (61,201) Expenses waived/paid by affiliates (Note 3f) .................................. (555,688) --------------- Net expenses ............................................................... 70,065,359 --------------- Net investment income ................................................... 93,718,031 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ............................................................. (1,202,940,543) Non-controlled affiliated issuers (Note 13) ...................................... 4,172,126 Written options ..................................................................... 1,180,565 Foreign currency transactions ....................................................... 229,556,539 Securities sold short ............................................................... 1,189,291 --------------- Net realized gain (loss) ................................................... (966,842,022) --------------- Net change in unrealized appreciation (depreciation) on: Investments ...................................................................... 1,763,132,957 Translation of other assets and liabilities denominated in foreign currencies .... (311,643,872) --------------- Net change in unrealized appreciation (depreciation) ....................... 1,451,489,085 --------------- Net realized and unrealized gain (loss) ................................................ 484,647,063 --------------- Net increase (decrease) in net assets resulting from operations ........................ $ 578,365,094 ===============
The accompanying notes are an integral part of these financial statements. 34 | Semiannual Report Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED JUNE 30, 2009 YEAR ENDED (UNAUDITED) DECEMBER 31, 2008 ---------------- ----------------- Increase (decrease) in net assets: Operations: Net investment income ................................................ $ 93,718,031 $ 384,719,913 Net realized gain (loss) from investments, written options, securities sold short and foreign currency transactions ...................... (966,842,022) (1,012,654,333) Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ............................................. 1,451,489,085 (8,435,202,719) --------------- ---------------- Net increase (decrease) in net assets resulting from operations ... 578,365,094 (9,063,137,139) --------------- ---------------- Distributions to shareholders from: Net investment income: Class Z ........................................................... -- (127,105,081) Class A ........................................................... -- (62,555,645) Class B ........................................................... -- (699,702) Class C ........................................................... -- (3,935,667) Class R ........................................................... -- (1,844,206) Net realized gains: Class Z ........................................................... -- (99,640,941) Class A ........................................................... -- (64,633,914) Class B ........................................................... -- (4,094,496) Class C ........................................................... -- (18,867,642) Class R ........................................................... -- (2,513,154) --------------- ---------------- Total distributions to shareholders ..................................... -- (385,890,448) --------------- ---------------- Capital share transactions: (Note 2) Class Z ........................................................... (298,539,953) (1,040,714,353) Class A ........................................................... (424,276,801) (637,960,764) Class B ........................................................... (40,982,524) (110,710,385) Class C ........................................................... (138,108,721) (384,748,179) Class R ........................................................... 1,151,237 (6,628,985) --------------- ---------------- Total capital share transactions ........................................ (900,756,762) (2,180,762,666) --------------- ---------------- Redemption fees ......................................................... -- 41,515 --------------- ---------------- Net increase (decrease) in net assets ............................. (322,391,668) (11,629,748,738) Net assets: Beginning of period ..................................................... 13,603,224,748 25,232,973,486 --------------- ---------------- End of period ........................................................... $13,280,833,080 $ 13,603,224,748 =============== ================ Undistributed net investment income included in net assets: End of period ........................................................... $ 278,740,559 $ 185,022,528 =============== ================
The accompanying notes are an integral part of these financial statements. Semiannual Report | 35 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual Shares Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers five classes of shares: Class Z, Class A, Class B, Class C, and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Senior secured corporate loans with floating or variable interest rates generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from loan dealers and other financial institutions, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services use independent market quotations from loan dealers or financial institutions and may incorporate valuation methodologies that consider multiple bond characteristics such as dealer quotes, issuer type, coupon, maturity, weighted average maturity, interest rate spreads and yield curves, cash flow and credit risk/quality analysis, to determine current value. 36 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Semiannual Report | 37 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) B. FOREIGN CURRENCY TRANSLATION (CONTINUED) Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. SECURITIES PURCHASED ON A DELAYED DELIVERY BASIS The Fund may purchase securities on a delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. D. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. 38 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) The Fund purchases or writes option contracts in order to manage equity price risk. An option is a contract entitling the holder to purchase or sell a specific amount of shares or units of a particular security, currency or index at a specified price. Options purchased are recorded as an asset while options written are recorded as a liability. Upon exercise of an option, the acquisition cost or sales proceeds of the security is adjusted by any premium paid or received. Upon expiration of an option, any premium paid or received is recorded as a realized loss or gain. Upon closing an option other than through expiration or exercise, the difference between the premium and the cost to close the position is recorded as a realized gain or loss. See Note 12 regarding other derivative information. E. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. F. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund incurs a loss if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit with broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. G. SPECIAL PURPOSE ENTITIES At June 30, 2009, the Fund contributed an additional $45,841,785 as a subordinated note holder of certain special purpose entities ("SPEs"). Such contributions, while made at the discretion of the Fund, represent additional capital contributions to the SPE in support of its underlying investments and are subject first to the claims of the senior note holders of the SPE. These contributions are recorded as an addition to the Fund's cost basis in the SPE and are subject to the risk of loss in the event of continued unfavorable market conditions related to the SPE's underlying investments. Semiannual Report | 39 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. At June 30, 2009, the Fund had no securities on loan. I. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. J. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 40 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS (CONTINUED) Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. L. REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the Fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. M. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. Semiannual Report | 41 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 --------------------------- ------------------------------ SHARES AMOUNT SHARES AMOUNT ----------- ------------- ------------ --------------- CLASS Z SHARES: Shares sold .................... 13,033,396 $ 197,362,336 21,247,862 $ 433,408,039 Shares issued in reinvestment of distributions ............... -- -- 11,801,196 209,921,901 Shares redeemed ................ (35,306,345) (495,902,289) (84,323,664) (1,684,044,293) ----------- ------------- ------------ --------------- Net increase (decrease) ........ (22,272,949) $(298,539,953) (51,274,606) $(1,040,714,353) =========== ============= ============ =============== CLASS A SHARES: Shares sold .................... 23,876,565 $ 348,288,588 76,308,129 $ 1,522,769,665 Shares issued in reinvestment of distributions ............... -- -- 6,333,689 114,388,652 Shares redeemed ................ (53,840,484) (772,565,389) (115,667,539) (2,275,119,081) ----------- ------------- ------------ --------------- Net increase (decrease) ........ (29,963,919) $(424,276,801) (33,025,721) $ (637,960,764) =========== ============= ============ =============== CLASS B SHARES: Shares sold .................... 168,074 $ 2,407,363 362,646 $ 7,153,214 Shares issued in reinvestment of distributions ............... -- -- 225,906 4,479,374 Shares redeemed ................ (3,086,383) (43,389,887) (6,173,610) (122,342,973) ----------- ------------- ------------ --------------- Net increase (decrease) ........ (2,918,309) $ (40,982,524) (5,585,058) $ (110,710,385) =========== ============= ============ =============== CLASS C SHARES: Shares sold .................... 3,251,469 $ 47,731,737 10,732,376 $ 210,664,085 Shares issued in reinvestment of distributions ............... -- -- 1,032,282 20,495,376 Shares redeemed ................ (13,127,735) (185,840,458) (31,195,589) (615,907,640) ----------- ------------- ------------ --------------- Net increase (decrease) ........ (9,876,266) $(138,108,721) (19,430,931) $ (384,748,179) =========== ============= ============ =============== CLASS R SHARES: Shares sold .................... 1,627,407 $ 23,815,190 3,686,186 $ 79,355,666 Shares issued in reinvestment of distributions ............... -- -- 235,917 4,330,719 Shares redeemed ................ (1,572,211) (22,663,953) (4,379,473) (90,315,370) ----------- ------------- ------------ --------------- Net increase (decrease) ........ 55,196 $ 1,151,237 (457,370) $ (6,628,985) =========== ============= ============ ===============
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
42 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- ------------------------------------------------- 0.600% Up to and including $5 billion 0.570% Over $5 billion, up to and including $10 billion 0.550% Over $10 billion, up to and including $15 billion 0.530% Over $15 billion, up to and including $20 billion 0.510% Over $20 billion, up to and including $25 billion 0.490% Over $25 billion, up to and including $30 billion 0.480% Over $30 billion, up to and including $35 billion 0.470% In excess of $35 billion
B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- --------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B, C, and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A... 0.35% Class B... 1.00% Class C... 1.00% Class R... 0.50%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. Semiannual Report | 43 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................. $922,674 Contingent deferred sales charges retained ...... $ 61,224
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $9,262,940, of which $5,611,688 was retained by Investor Services. F. SPECIAL SERVICING AGREEMENT Effective May 1, 2009, the Fund, which is an underlying investment of one or more of the Franklin Templeton Fund Allocator Series Funds (Allocator Funds), entered into a Special Servicing Agreement with the Allocator Funds, pursuant to which the Fund pays a portion of eligible Allocator Funds' expenses, which include transfer agency and shareholder service costs, to the extent such payments are less than the amount of the benefits realized or expected to be realized by the Fund from the investment in the Fund by the Allocator Funds. Expenses allocated to the Fund under the Special Servicing Agreement are included in transfer agent fees on the Statement of Operations, and the amount payable to the Allocator Funds is included in the payable to affiliates on the Statement of Assets and Liabilities. For the period ended June 30, 2009, the Fund was allocated expenses of $997,553. The investment manager and administrative manager of the Fund have voluntarily agreed to limit the increase in the Fund's net annual operating expense ratio that results from the implementation of the Special Servicing Agreement at 0.02% through April 30, 2010. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. 44 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN (CONTINUED) During the period ended June 30, 2009, the Fund's projected benefit obligation and benefit payments under the plan were as follows: (a)Projected benefit obligation at June 30, 2009 ... $489,477 (b)Increase in projected benefit obligation ........ $ 21,687 Benefit payments made to retired trustees ....... $ 10,516
(a) The projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is included in trustees' fees and expenses in the Statement of Operations. 6. INCOME TAXES For tax purposes, capital losses may be carried over to offset future capital gains, if any. At December 31, 2008, the Fund had tax basis capital losses of $246,320,571 expiring in 2016. For tax purposes, realized capital losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses of $579,189,099. At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ................................ $16,256,567,959 =============== Unrealized appreciation ............................ $ 1,481,640,475 Unrealized depreciation ............................ (4,228,925,667) --------------- Net unrealized appreciation (depreciation) ......... $(2,747,285,192) ===============
Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through entity income, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, pass-through entity income, bond discounts and premiums, tax straddles, and certain dividend on securities sold short. 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $2,890,987,551 and $2,705,328,881, respectively. Semiannual Report | 45 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 7. INVESTMENT TRANSACTIONS (CONTINUED) Transactions in options written during the period ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED --------- ----------- Options outstanding at December 31, 2008 .... 7,354 $ 1,185,782 Options written ............................. 13,248 1,010,789 Options expired ............................. (7,329) (1,180,565) Options exercised ........................... (25) (5,217) Options closed .............................. -- -- ------ ----------- Options outstanding at June 30, 2009 ........ 13,248 $ 1,010,789 ====== ===========
8. CREDIT RISK AND DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. If it becomes probable that income on debt securities, including those of distressed companies, will not be collected, the Fund discontinues accruing income and recognizes a reserve for uncollectible interest. At June 30, 2009, the aggregate value of distressed company securities and securities for which interest has been discontinued was $191,138,157, representing 1.44% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. 46 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED) At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ------------------------------------------ ------------------ ------------ ------------ 842,420 AboveNet Inc. ............................ 10/02/01 - 8/08/08 $ 44,630,142 $ 68,219,172 1,065 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ....... 4/17/06 - 9/08/06 -- 63,932 34,449 AboveNet Inc., wts., 9/08/10 ............. 10/02/01 - 9/07/07 3,603,181 1,980,817 43,105,703 CB FIM Coinvestors LLC ................... 1/15/09 - 6/02/09 43,105,703 98,418,941 56,116,385 Cerberus CG Investor I LLC ............... 7/26/07 - 6/17/08 55,924,193 10,662,113 49,252,400 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............................... 7/26/07 49,252,400 9,357,956 56,116,385 Cerberus CG Investor II LLC .............. 7/26/07 - 6/17/08 55,924,193 10,662,113 49,252,400 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............................... 7/26/07 49,252,400 9,357,956 28,058,192 Cerberus CG Investor III LLC ............. 7/26/07 - 6/17/08 27,962,097 5,331,056 24,626,200 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............................... 7/26/07 24,626,200 4,678,978 53,924,666 Cerberus FIM Investors Holdco LLC ........ 11/20/06 - 6/02/09 53,924,666 3,925,716 159,591,548 Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ...................... 11/20/06 159,591,548 11,610,445 1,879,100 (a) DecisionOne Corp. .................... 3/12/99 - 7/18/00 1,313,384 3,100,515 2,467,888 (a) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 ................ 6/01/09 2,467,888 2,755,397 1,031,766 (a)DecisionOne Corp., wts., 6/08/17 ...... 7/09/07 -- -- 64,834 Elephant Capital Holdings Ltd. ........... 8/29/03 - 3/10/08 7,540,574 -- 22,185,100 GLCP Harrah's Investment LP .............. 1/15/08 22,185,100 -- 678,719 IACNA Investor LLC ....................... 7/24/08 695,349 6,787 7,234,813 International Automotive Components Group Brazil LLC ...................... 4/13/06 - 12/26/08 4,853,277 6,478,345 1,104,272 International Automotive Components Group Japan LLC ....................... 9/26/06 - 3/27/07 9,586,763 3,054,740 25,796,752 (b) International Automotive Components Group LLC ............................. 1/12/06 - 10/16/06 25,803,435 5,853,283 5,851,000 International Automotive Components Group NA LLC, 9.00%, 4/01/17 .......... 3/30/07 5,938,765 2,654,791 19,434,979 International Automotive Components Group NA LLC, A ............................. 3/30/07 - 10/10/07 19,238,439 740,473 11,211 Motor Coach Industries International Inc. .................................. 4/17/09 12,907,338 14,579,905 80,429 Motor Coach Industries International Inc., pfd. ............................ 4/17/09 80,429,000 80,429,000 301,530 NCB Warrant Holdings Ltd., A ............. 12/16/05 - 3/10/08 3,174,787 -- 202,380 Olympus Re Holdings Ltd. ................. 12/19/01 19,570,491 442,281
Semiannual Report | 47 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ------------------------------------------ ------------------ ------------ ------------ 72,804,274 Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ....................... 1/22/08 - 2/25/08 $101,303,685 $ 69,859,566 11,547,071 Pontus II Trust, junior profit- participating note, 144A, FRN, 7.66%, 6/25/09 ............................... 2/29/08 28,889,445 20,115,930 199,566 PTV Inc., 10.00%, pfd., A ................ 12/07/01 - 3/06/02 125,727 47,896 ------------ TOTAL RESTRICTED SECURITIES (3.35% of Net Assets) ........................ $444,388,104 ============
(a) The Fund also invests in unrestricted securities of the issuer, valued at $483,826 as of June 30, 2009. (b) The Fund also invests in unrestricted securities of the issuer, valued at $3,854,095 as of June 30, 2009. 10. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. Funded portions of credit agreements are presented on the Statements of Investments. At June 30, 2009, unfunded commitments were as follows:
UNFUNDED COMMITMENT ---------- BORROWER Realogy Corp., Revolver, FRN, 3.427%, 4/10/13 ........ $8,526,635
Unfunded loan commitments and funded portions of credit agreements are marked to market daily and any unrealized appreciation or depreciation is included in the Statement of Assets and Liabilities and Statement of Operations. 11. UNFUNDED CAPITAL COMMITMENTS The Fund may enter into certain capital commitments and may be obligated to perform on such agreements at a future date. Unfunded capital commitments requiring recognition are monitored for impairment and any unrealized deprecation is included in the Statement of Assets and Liabilities and the Statement of Operations. At June 30, 2009, the Fund had aggregate unfunded capital commitments of $22,412,357, for which no depreciation has been recognized. 48 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 12. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS ASSET DERIVATIVES LIABILITY DERIVATIVES HEDGING INSTRUMENTS ---------------------------------------- ----------------------------------------- UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ----------- -------------------------- ------------ Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $ 4,511,262 forward exchange contracts $227,386,124 Equity contracts ... Investments, at value 20,172,332 Options written, at value 2,609,856
For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- -------------------------------------------- -------------- -------------- ------------- Foreign exchange contracts ...... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $229,741,236 $(311,649,892) 3,353,551,446 Equity contracts ... Net realized gain (loss) from investments and written options/Net change in unrealized appreciation (depreciation) on investments 1,152,644 (27,936,347) 10,595
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(d) regarding derivative financial instruments. Semiannual Report | 49 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund for the period ended June 30, 2009, were as shown below.
NUMBER OF NUMBER OF SHARES/ SHARES/ WARRANTS/ WARRANTS/ CONTRACTS/ CONTRACTS/ PRINCIPAL PRINCIPAL AMOUNT AMOUNT HELD AT HELD AT VALUE AT REALIZED BEGINNING GROSS GROSS END END OF INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME GAIN (LOSS) - -------------- ---------- ---------- ---------- ---------- ------------ ---------- ----------- CONTROLLED AFFILIATES(a) CB FIM Coinvestors LLC .......... -- 43,105,703 -- 43,105,703 $ 98,418,941 $ -- $ -- Motor Coach Industries International Inc. ........... -- 11,211 -- 11,211 14,579,905 -- -- Motor Coach Industries International Inc., pfd. ..... -- 80,429 -- 80,429 80,429,000 -- -- ------------ -------- ---------- TOTAL CONTROLLED AFFILIATES ..... $193,427,846 $ -- $ -- ============ ======== ========== NON-CONTROLLED AFFILIATES AboveNet Inc. ................... 842,420 -- -- 842,420 $ 68,219,172 $ -- $ -- AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ................. 1,065 -- -- 1,065 63,932 -- -- AboveNet Inc., wts., 9/08/10 .... 34,449 -- -- 34,449 1,980,817 -- -- Alexander's Inc. ................ 326,675 -- -- 326,675 88,071,580 -- -- Community Health Systems Inc. ... 4,806,000 -- -- 4,806,000 121,351,500 -- -- DecisionOne Corp. ............... 1,879,100 -- -- 1,879,100 3,100,515 -- -- DecisionOne Corp., 12.00%, 4/15/10 ...................... 2,418,729 49,159 2,467,888 -- -- 145,865 (642,512) DecisionOne Corp., Term Loan B, 15.00%, 8/29/13 .............. 433,342 -- -- 433,342 483,826 13,054 -- DecisionOne Corp., senior secured note, 15.00%, 11/30/13 ....... -- 2,467,888 -- 2,467,888 2,755,397 -- -- DecisionOne Corp., wts., 6/8/17 . 1,031,766 -- -- 1,031,766 -- -- -- Elephant Capital Holdings Ltd. .. 64,834 -- -- 64,834 -- -- -- Federal Signal Corp. ............ 3,360,800 -- -- 3,360,800 25,710,120 403,296 -- GLCP Harrah's Investment LP ..... 22,185,100 -- -- 22,185,100 -- -- -- Guaranty Bancorp ................ 5,731,834 -- -- 5,731,834 10,947,803 -- -- IACNA Investor LLC .............. 678,719 -- -- 678,719 6,787 -- -- International Automotive Components Group Brazil LLC .. 7,234,813 -- -- 7,234,813 6,478,345 -- -- International Automotive Components Group Japan LLC ... 1,104,272 -- -- 1,104,272 3,054,740 -- -- International Automotive Components Group LLC ......... 25,796,752 -- -- 25,796,752 5,853,283 -- -- International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............... 5,851,000 -- -- 5,851,000 2,654,791 -- -- International Automotive Components Group NA LLC, A ... 19,434,979 -- -- 19,434,979 740,473 -- -- International Automotive Components Group NA Inc., Revolver, FRN, 5.75%, 1/18/14 ...................... -- 3,854,095 -- 3,854,095 3,854,095 66,483 -- Kindred Healthcare Inc. ......... 2,883,197 -- 1,441,598 1,441,599 --(b) -- 4,814,638 Tenet Healthcare Corp. .......... 25,881,411 -- -- 25,881,411 72,985,579 -- --
50 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
NUMBER OF NUMBER OF SHARES/ SHARES/ WARRANTS/ WARRANTS/ CONTRACTS/ CONTRACTS/ PRINCIPAL PRINCIPAL AMOUNT AMOUNT HELD AT HELD AT VALUE AT REALIZED BEGINNING GROSS GROSS END END OF INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME GAIN (LOSS) - -------------- ---------- ---------- ---------- ---------- ------------ ---------- ----------- NON-CONTROLLED AFFILIATES (CONTINUED) TVMAX Holdings Inc............... 257,217 -- -- 257,217 $ -- $ -- $ -- TVMAX Holdings Inc., PIK, 11.50%, 9/30/09 ...................... 978,922 224,935 -- 1,203,857 338,050 62,877 -- TVMAX Holdings Inc., PIK, 14.00%, 9/30/09 ...................... 1,838,287 134,003 -- 1,972,290 532,737 132,535 -- White Mountains Insurance Group Ltd. ................... 729,457 -- -- 729,457 166,980,002 729,457 -- ------------ ---------- ---------- TOTAL NON-CONTROLLED AFFILIATES ................................................. $586,163,544 $1,553,567 $4,172,126 ============ ========== ========== TOTAL AFFILIATED SECURITIES (5.87% of Net Assets) ............................ $779,591,390 $1,553,567 $4,172,126 ============ ========== ==========
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. (b) As of June 30, 2009, no longer an affiliate. 14. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Franklin Mutual serves as investment manager to certain special purpose entities that issue securities held by the Fund. Franklin Mutual is not compensated for such services and does not invest in or exercise control over such entities. As investment manager, Franklin Mutual is primarily responsible for recommending investments in unaffiliated issuers to be held by the special purpose entities. Securities issued by these special purpose entities are restricted under the Securities Act of 1933 and are deemed to be illiquid. 15. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. Semiannual Report | 51 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 15. CREDIT FACILITY (CONTINUED) Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $43,003 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statement of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 16. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL --------------- ------------ ------------ --------------- ASSETS: Investments in Securities: Equity Investments:(a) Airlines ......................... $ 5,756,376 $ 70,149 $ -- $ 5,826,525 Auto Components .................. 48,352,455 -- 16,172,085 64,524,540 Chemicals ........................ 215,231,426 -- 3,157,637 218,389,063 Commercial Services & Supplies ...................... 15,491 -- --(b) 15,491 Computers & Peripherals .......... 256,688,645 -- 3,100,515 259,789,160 Consumer Finance ................. -- -- 128,999,939 128,999,939 Diversified Financial Services ... 96,207,432 -- --(b) 96,207,432 Diversified Telecommunication Services ...................... 453,995,097 2,028,713 --(b) 456,023,810 Insurance ........................ 934,052,716 -- 442,281 934,494,997 Machinery ........................ 118,169,682 -- 95,008,905 213,178,587 Media ............................ 658,796,741 4,780,162 --(b) 663,576,903
52 | Semiannual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS (CONTINUED)
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL --------------- ------------ ------------ --------------- ASSETS: (CONTINUED) Investments in Securities: (CONTINUED) Equity Investments: (a) (CONTINUED) Multi-Utilities .................. $ 68,126,191 $ -- $ --(b) $ 68,126,191 Real Estate Management & Development ................... 46,659,136 -- 41,068,150 87,727,286 All other Equity Investments(c) .. 8,334,241,625 -- -- 8,334,241,625 Options Purchased ................... 20,108,400 -- -- 20,108,400 Corporate Bonds, Notes & Senior Floating Rate Interests .......... -- 413,329,648 135,599,727 548,929,375 Corporate Bonds, Notes & Senior Floating Rate Interests in Reorganization ................... -- 153,477,606 425 153,478,031 Companies in Liquidation ............ -- -- --(b) -- Short Term Investments ................. 849,571,215 406,074,197 -- 1,255,645,412 --------------- ------------ ------------ --------------- Total Investments in Securities ........ $12,105,972,628 $979,760,475 $423,549,664 $13,509,282,767 =============== ============ ============ =============== Forward Exchange Contracts ................ $ -- $ 4,511,262 $ -- $ 4,511,262 LIABILITIES: Options Written ........................ 2,609,856 -- -- 2,609,856 Securities Sold Short .................. 227,433,112 -- -- 227,433,112 Forward Exchange Contracts ............. -- 227,386,124 -- 227,386,124 Unfunded Loan Commitments .............. -- 1,079,076 -- 1,079,076
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN NET UNREALIZED NET BEGINNING REALIZED APPRECIATION PURCHASES BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) ------------- ------------ -------------- ------------- ASSETS: Investment in Securities: Equity Investments:(a) Auto Components ............... $ 14,546,880 $ -- $ 1,649,493 $ (24,288) Chemicals ..................... 3,157,637 -- -- -- Commercial Services & Supplies ................... -- -- -- -- Computers & Peripherals ....... -- -- 3,100,515 -- Consumer Finance .............. 39,327,475 -- 47,047,241 42,625,223 Diversified Financial Services ................... 6,655,530 -- (6,655,530) -- NET CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) ATTRIBUTABLE TRANSFER TO ASSETS IN (OUT) OF ENDING STILL HELD LEVEL 3 BALANCE AT PERIOD END ------------- ------------ -------------- ASSETS: Investment in Securities: Equity Investments:(a) Auto Components ............... $ -- $ 16,172,085 $ 1,649,493 Chemicals ..................... -- 3,157,637 -- Commercial Services & Supplies ................... -- --(b) -- Computers & Peripherals ....... -- 3,100,515 3,100,515 Consumer Finance .............. -- 128,999,939 47,047,241 Diversified Financial Services ................... -- --(b) (6,655,530)
Semiannual Report | 53 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS (CONTINUED)
NET CHANGE IN NET UNREALIZED NET BEGINNING REALIZED APPRECIATION PURCHASES BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) ------------- ------------ -------------- ------------- ASSETS: (CONTINUED) Investment in Securities: (CONTINUED) Equity Investments: (a) (CONTINUED) Diversified Telecommunication Services ................... $42,261,192 $ -- $ 25,259,361 $ -- Health Care Providers & Services ................... 35,662,264 -- 4,926,786 -- Insurance ..................... 475,107 -- (32,826) -- Machinery ..................... -- -- 1,672,567 93,336,338 Media ......................... -- -- -- -- Multi-Utilities ............... -- -- -- -- Real Estate Management & Development ................ 54,978,930 -- (13,910,780) -- Corporate Bonds, Notes & Senior Floating Rate Interests .... 247,021,002 (593,852) 6,598,800 (117,426,223) Corporate Bonds, Notes & Senior Floating Rate Interests in Reorganization ............. 1,858,494 (55,153,784) 66,203,053 (12,907,338) Companies in Liquidation ...... -- -- -- -- ------------ ------------ ------------- ------------- Total ............................ $445,944,511 $(55,747,636) $ 135,858,680 $ 5,603,712 ============ ============ ============= ============= NET CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) ATTRIBUTABLE TRANSFER TO ASSETS IN (OUT) OF ENDING STILL HELD LEVEL 3 BALANCE AT PERIOD END ------------- ------------ -------------- ASSETS: (CONTINUED) Investment in Securities: (CONTINUED) Equity Investments:(a) (CONTINUED) Diversified Telecommunication Services ................... $ (67,520,553) $ --(b) $ -- Health Care Providers & Services ................... (40,589,050) -- -- Insurance ..................... -- 442,281 (32,826) Machinery ..................... -- 95,008,905 1,672,567 Media ......................... -- --(b) -- Multi-Utilities ............... -- --(b) -- Real Estate Management & Development ................ -- 41,068,150 (13,910,780) Corporate Bonds, Notes & Senior Floating Rate Interests .... -- 135,599,727 (2,315,051) Corporate Bonds, Notes & Senior Floating Rate Interests in Reorganization ............. -- 425 -- Companies in Liquidation ...... -- --(b) -- ------------- ------------ ------------ Total ............................ $(108,109,603) $423,549,664 $ 30,555,629 ============= ============ ============
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. 17. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 18, 2009 and determined that no events have occurred that require disclosure. ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound JPY - Japanese Yen SELECTED PORTFOLIO ADR - American Depository Receipt DIP - Debtor-In-Possession FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. 54 | Semiannual Report Mutual Shares Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. Semiannual Report | 55 Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counterparty credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and 56 | Semiannual Report Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) its long-term relationship with the Fund as reasons that shareholders choose to invest, and remain invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative Semiannual Report | 57 Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional multi-cap value funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the middle performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the middle and second-best performing quintiles, respectively. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quintile and exceeded 3%, as shown in the Lipper Section 15(c) Report. The Board was satisfied with such comparative performance. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's middle, second-best and best performing quintiles of peer funds for the three-, five- and 10-year periods ended December 31, 2008, respectively. The trustees concluded that, while the Fund's losses over the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years. The trustees noted that the Fund's overall expense ratio has declined over such period. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense 58 | Semiannual Report Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the middle quintile of its Lipper expense group and its total expenses were in the middle quintile of such group. The Board was satisfied with such comparative expenses. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative relationship of investment management and underwriting expenses; shareholder servicing profitability; economies of scale; and the relative contribution of the Fund to the profitability of the Semiannual Report | 59 Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004, with additional breakpoints being added as deemed appropriate by the Board. The trustees assessed the savings to shareholders resulting from such breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor the appropriateness of the breakpoints. The trustees also considered the effects an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. 60 | Semiannual Report Mutual Shares Fund SHAREHOLDER INFORMATION (CONTINUED) PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. Semiannual Report | 61 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL SHARES FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B, C & R) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 474 S2009 08/09 JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER (GRAPHIC) SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" VALUE MUTUAL QUEST FUND (FORMERLY, MUTUAL QUALIFIED FUND) (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services. MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER........................................................ 1 SEMIANNUAL REPORT Mutual Quest Fund......................................................... 4 Performance Summary....................................................... 11 Your Fund's Expenses...................................................... 14 Financial Highlights and Statement of Investments......................... 16 Financial Statements...................................................... 31 Notes to Financial Statements............................................. 35 Shareholder Information................................................... 52
Shareholder Letter Dear Mutual Quest Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In the U.S. and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. During the period, the U.S. unemployment rate rose to its highest level in 25 years, housing prices continued their precipitous declines and 30-year U.S. Treasury yields plummeted to a 30-year low of around 2.5%, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of financial services companies on the scale of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of major bank nationalization was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The low in early March for the Standard & Poor's 500 Index -- down 26% from 2008 year-end and 57% from its peak in October 2007 -- was followed by a 42% rebound to its recent, second-quarter high on June 11.(1) The 57% drop was the third worst since 1900.1 At the same time, yields on 30-year Treasuries shot up to 4.8% in June, resulting in their worst six-month performance in over 16 years. (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Standard & Poor's 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The index is one of the most widely used benchmarks of U.S. equity performance. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed that the recovery in Europe would be slower than in the U.S. Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, the results of the government "stress test" of major financial institutions were generally positive, enabling many of those institutions to raise capital in the public markets and avoid a worst-case scenario of government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Additionally, the bankruptcies of General Motors and Chrysler, although particularly painful for dealers, suppliers and those directly dependent on the auto industry, were absorbed without triggering further systemic risk. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual Quest Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities, attractive merger arbitrage situations, and distressed debt opportunities. Consistent with the expectations outlined in our 2008 year-end letter, we added to companies in economically defensive industries, with strong market positions, high barriers to entry, and reasonably predictable earnings and cash flows, including companies in the consumer staples sector and the health care sector. We also anticipated purchases in some economically sensitive industries, and likewise increased our investments in some energy companies where we believe we found good value. Late in 2008 and early in 2009, we began to find opportunities in senior secured corporate loans trading at levels we perceived reflected mispriced risk. These are exactly the types of opportunities that we patiently wait for and that we had not seen since the last big credit default cycle of 2001-2003, immediately following the frauds at Enron, Tyco and WorldCom. On the bankruptcy 2 | Not part of the semiannual report front recently, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we like, although we expect more of these as "covenant lite," highly leveraged balance sheets eventually reach a tipping point. On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. However, a few large health care deals did emerge as those acquirers took advantage of their relatively stable cash flows and strong balance sheets to pursue a needed rationalization of the industry. The good news here is that we believe the potential returns for these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual Quest Fund (formerly, Mutual Qualified Fund) YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Quest Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 50% of its assets in foreign securities. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. We are pleased to bring you Mutual Quest Fund's semiannual report for the period ended June 30, 2009. The Fund's goal and strategy have not changed; however we renamed the Fund to avoid any misinterpretation that Mutual Qualified Fund is for qualified investors only. PERFORMANCE OVERVIEW Mutual Quest Fund - Class Z delivered a +5.41% cumulative total return for the six months ended June 30, 2009. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which had a +3.16% total return for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the six-month period ended June 30, 2009, the U.S. economy and stock markets seemed to stabilize after signs appeared that the recession's severity had eased. Strains on the banking system and credit markets that surfaced in 2008 improved in 2009's first half with the help of federal aid and tighter regulations. Despite rising unemployment, near period-end home sales edged higher, the (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 21. 4 | Semiannual Report decline in manufacturing activity slowed and consumer confidence started to pick up. Economic activity as measured by gross domestic product (GDP) fell at annualized rates of 6.4% and an estimated 1.0% in the first and second quarters of 2009. Although the price of oil rose from $44 per barrel at the beginning of the period to $70 by period-end on speculation that the downturn was abating, it was still off more than 50% from its July 2008 record high.(2) June's inflation rate, as measured by the Consumer Price Index, was an annualized -1.4%, representing the steepest yearly decline in the cost of living in nearly six decades.(3) Core inflation, which excludes food and energy costs, rose at a 1.7% annualized rate, which was within the Federal Reserve Board's (Fed's) informal target range of 1.5%-2.0%.(3) A deepening recession and decelerating inflation prompted Washington policy-makers to keep interest rates low and enact stimulus plans -- including income tax cuts, aid to ailing state governments and funding for transportation infrastructure, school construction and high-tech projects. During the period under review, the Fed kept the federal funds target rate in a range of 0% to 0.25% and said the "pace of economic contraction is slowing" but the financial system had not yet returned to normal. Most U.S. stocks suffered major losses through early March as investors worried about an uncertain future. Stocks then recovered somewhat from 12-year lows as investors perceived many bargains among the bear market fallout and data indicated the economy's pace of contraction was moderating. By June, however, fresh investor concerns about the economy and stock valuations reemerged and dampened the rally's momentum. For the six months under review, the blue chip stocks of the Dow Jones Industrial Average had a total return of -2.01%, while the broader S&P 500 posted a +3.16% total return and the technology-heavy NASDAQ Composite Index returned +16.99%.(4) Global equities followed the same trend. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) U.S. 28.2% France 9.1% U.K. 8.2% Switzerland 3.9% Germany 3.1% Norway 2.3% South Korea 2.2% Finland 1.9% Bermuda 1.9% Hong Kong 1.7% Netherlands 1.3% Other 3.2% Short-Term Investments & Other Net Assets 33.0%
(2.) Source: New York Mercantile Exchange. (3.) Source: Bureau of Labor Statistics. (4.) Source: (C) 2009 Morningstar. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. Semiannual Report | 5 appetite, rotating capital back into cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Tobacco 13.0% Food Products 8.8% Pharmaceuticals 7.6% Insurance 6.7% Energy Equipment & Services 3.6% Beverages 3.2% Oil, Gas & Consumable Fuels 2.5% Machinery 2.2% Industrial Conglomerates 2.1% Real Estate Investment Trusts 1.8%
In the reporting period's final weeks, global equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(5) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(6) INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of (5.) Source: European Communities Eurostat. (6.) Source: People's Bank of China. 6 | Semiannual Report substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION During the first half of 2009, Mutual Quest Fund's best performing investments included Kone, a Finnish engineering and service company specializing in elevator and escalator installation and servicing; Marine Harvest, a Norway- based farmed salmon producer; and Seadrill, a Norwegian deepwater contract driller. Kone's share price appreciated during the six-month period as it booked more orders than expected, which covered over 12 months of sales and allowed it to beat analysts' first quarter 2009 earnings forecasts. Kone gained market share in the U.S. and China, where economic stimulus was having a real impact. The company became particularly well positioned in China as it recently developed its business in the country's western region -- an area experiencing high growth rates and one where Kone faces less competition. In addition, to prepare for less new equipment activity globally in 2010, Kone announced a program to lower its fixed costs. TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Schering-Plough Corp. 3.6% PHARMACEUTICALS, U.S. Wyeth 3.5% PHARMACEUTICALS, U.S. Lorillard Inc. 3.3% TOBACCO, U.S. Danone 3.2% FOOD PRODUCTS, FRANCE British American Tobacco PLC 2.6% TOBACCO, U.K. Berkshire Hathaway Inc., A & B 2.1% INSURANCE, U.S. Nestle SA 2.0% FOOD PRODUCTS, SWITZERLAND Kone OYJ, B 1.9% MACHINERY, FINLAND White Mountains Insurance Group Ltd. 1.7% INSURANCE, U.S. Pernod Ricard SA 1.7% BEVERAGES, FRANCE
Semiannual Report | 7 Investor concerns about Chilean salmon production sent Marine Harvest's share price plunging in 2008. In our view, investors had forgotten that lower salmon supply would normally translate into higher prices. As salmon prices increased by more than 40% during the first half of 2009, Marine Harvest's cash flow increased and it regained investor interest. Besides operational gearing, financial gearing also positively affected Marine Harvest's share price. Largely as a result of these conditions, Marine Harvest's share price roughly quadrupled during the six-month period. Seadrill's share price benefited from the resilience of the deepwater drilling segment in terms of day rates. Brazilian national oil company Petrobras continued its multiyear effort to tender for additional deepwater offshore drilling rigs and develop the country's claim to the vast and recently discovered Tupi underwater oil field. According to our analysis, Seadrill is extremely well positioned in this regard because it still had some of its modern, highly specialized rigs available for use, while being among the very few suppliers not facing financing issues, and while also being able to deliver its equipment on schedule. At period-end, Seadrill was in the process of refinancing its debt and could begin paying a dividend in the second half of 2009. Although the Fund held several positions that made significant positive contributions during the first half 2009, it also had some underachievers. Three investments that failed to meet our expectations during the period were U.S.-based property and casualty insurance and reinsurance company White Mountains Insurance Group; Danone, a French food processing company; and Berkshire Hathaway, a U.S. conglomerate headed by Warren Buffet. White Mountains suffered early in the year from an investment portfolio leveraged to equities, what the company saw as a mismanaged life reinsurance portfolio in Japan, and the subsequent erosion of its capital position that was exacerbated by the buy-back of Berkshire Hathaway's holding. The company took corrective actions by reducing its equity exposure and neutralizing its life reinsurance book, reportedly with a view to exiting that business. The company's core underwriting businesses were apparently performing well, however, and at period-end we think the stock could recover from these oversold levels if the market recognizes what we see as the intrinsic value of these businesses. Even though Danone reported some encouraging operational numbers, its share price was negatively impacted when the company decided to issue E3 billion in equity at the end of May. This news surprised the market, which focused on the short-term dilution and the decision by one of the company's largest shareholders not to participate in the offering. We added to the Fund's existing Danone position during the equity issuance at a share price we believed to be a discount to its historical valuation. 8 | Semiannual Report Berkshire Hathaway shares underperformed as investors switched into financials that were perceived to be more sensitive to the upside in capital markets. Investors also continued to exhibit concern over the long-term put options written by Berkshire that would be triggered if equity markets continued to sustain substantial declines. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual Quest Fund. We look forward to serving your future investment needs. (PHOTO OF ANNE E. GUDEFIN) /s/ Anne E. Gudefin Anne E. Gudefin, CFA Portfolio Manager (PHOTO OF SHAWN M. TUMULTY) /s/ Shawn M. Tumulty Shawn M. Tumulty, CFA Assistant Portfolio Manager Mutual Quest Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Semiannual Report | 9 ANNE GUDEFIN has been portfolio manager for Mutual Quest Fund since 2002. She is also portfolio manager for Mutual Global Discovery Fund and has been a member of the management team of the Mutual Series Funds since 2000, when she joined Franklin Templeton Investments. Previously, she was an analyst at Perry Capital. SHAWN TUMULTY has been assistant portfolio manager for Mutual Quest Fund since 2003. He joined Franklin Templeton Investments in 2000. Prior to joining Franklin Templeton Investments, Mr. Tumulty was an analyst and portfolio manager at Hamilton Partners Limited. 10 | Semiannual Report Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: MQIFX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.79 $15.38 $14.59
CLASS A (SYMBOL: TEQIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.76 $15.26 $14.50
CLASS B (SYMBOL: TEBQX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.69 $14.88 $14.19
CLASS C (SYMBOL: TEMQX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.70 $15.08 $14.38
CLASS R (SYMBOL: N/A) CHANGE 6/30/09 5/1/09 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.60 $15.24 $14.64
Semiannual Report | 11 Performance Summary (CONTINUED) PERFORMANCE CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL AND AGGREGATE TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES CLASS Z/R: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +5.41% -13.50% +28.90% +82.31% Average Annual Total Return(3) +5.41% -13.50% +5.21% +6.19% Value of $10,000 Investment(4) $10,541 $8,650 $12,890 $18,231 Total Annual Operating Expenses(5) 0.81%
CLASS A(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +5.24% -13.79% +26.77% +76.16% Average Annual Total Return(3) -0.78% -18.73% +3.62% + 5.20% Value of $10,000 Investment(4) $9,922 $8,127 $11,946 $16,606 Total Annual Operating Expenses(5) 1.11%
CLASS B(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +4.86% -14.34% +22.69% +67.30% Average Annual Total Return(3) +0.86% -17.44% +3.89% +5.28% Value of $10,000 Investment(4) $10,027 $8,256 $12,103 $16,730 Total Annual Operating Expenses(5) 1.81%
CLASS C(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +4.87% -14.38% +22.62% +65.00% Average Annual Total Return(3) +3.87% -15.16% +4.16% +5.14% Value of $10,000 Investment(4) $10,387 $8,484 $12,262 $16,500 Total Annual Operating Expenses(5) 1.80%
CLASS R INCEPTION (5/1/09) - ------- ------------------ Cumulative Total Return(2) +4.10% Aggregate Total Return(6) +4.10% Value of $10,000 Investment(4) $10,410 Total Annual Operating Expenses(5) 1.31%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. 12 | Semiannual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS AND FOREIGN SECURITIES INVOLVE SPECIAL RISKS. SMALLER-COMPANY STOCKS HAVE EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS, AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. CLASS R: Shares available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. (1.) Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the periods indicated. (3.) Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. (6.) Aggregate total return represents the change in value of an investment over the period shown. Since Class R shares have existed for less than one year, average annual total returns are not available. Semiannual Report | 13 Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Semiannual Report Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 ----------------- -------------- ---------------------- CLASS Z Actual $1,000 $1,054.10 $4.63 Hypothetical (5% return before expenses) $1,000 $1,020.28 $4.56 CLASS A Actual $1,000 $1,052.40 $6.21 Hypothetical (5% return before expenses) $1,000 $1,018.74 $6.11 CLASS B Actual $1,000 $1,048.60 $9.70 Hypothetical (5% return before expenses) $1,000 $1,015.32 $9.54 CLASS C Actual $1,000 $1,048.70 $9.70 Hypothetical (5% return before expenses) $1,000 $1,015.32 $9.54 CLASS R Actual (5/1/09-6/30/09) $1,000 $1,041.00 $2.37 Hypothetical (5% return before expenses) $1,000 $1,017.80 $7.05
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 0.91%; A: 1.22%; B: 1.91%; C: 1.91%; and R: 1.41%), multiplied by the average account value over the period, multiplied by 181/365 (Hypothetical for Classes Z, A, C and R) to reflect the one-half year period. For Actual Class R expenses, the multiplier is 60/365 to reflect the number of days since inception. Semiannual Report | 15 Mutual Quest Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------- CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ----------- ----------- ----------- ----------- ----------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .. $ 14.59 $ 21.84 $ 21.88 $ 19.81 $ 19.49 $ 17.88 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ........... 0.10(c) 0.38 0.61 0.38 0.41 0.37 Net realized and unrealized gains (losses) ........................ 0.69 (5.90) 1.37 3.39 1.77 2.56 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ...... 0.79 (5.52) 1.98 3.77 2.18 2.93 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income .............. -- (0.32) (0.71) (0.40) (0.42) (0.39) Net realized gains ................. -- (1.41) (1.31) (1.30) (1.44) (0.93) ---------- ---------- ---------- ---------- ---------- ---------- Total distributions ................... -- (1.73) (2.02) (1.70) (1.86) (1.32) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) .................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ........ $ 15.38 $ 14.59 $ 21.84 $ 21.88 $ 19.81 $ 19.49 ========== ========== ========== ========== ========== ========== Total return(f) ....................... 5.41% (25.34)% 9.12% 19.29% 11.26% 16.64% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) .. 0.92% 0.81% 0.80% 0.83% 0.85% 0.82% Expenses net of expense reduction(h) .. 0.91% 0.81% 0.80% 0.83% 0.85% 0.82% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction .. 0.82% 0.81% 0.79% 0.81% 0.81% 0.81% Expenses net of expense reduction .. 0.81% 0.81% 0.79% 0.81% 0.81% 0.81% Net investment income ................. 1.41%(c) 1.97% 2.58% 1.77% 2.04% 2.01% SUPPLEMENTAL DATA Net assets, end of period (000's) ..... $3,191,340 $3,071,302 $4,421,592 $4,200,899 $3,646,593 $3,419,744 Portfolio turnover rate ............... 13.33% 25.52% 26.25% 23.64% 20.98% 37.61%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 2.09%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual Quest Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ----------------------------------------------------------- CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- --------- ----------- --------- --------- --------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 14.50 $ 21.70 $ 21.75 $ 19.71 $ 19.41 $ 17.81 -------- -------- ---------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.08(c) 0.32 0.52 0.31 0.34 0.31 Net realized and unrealized gains (losses) ........................... 0.68 (5.85) 1.38 3.36 1.75 2.55 -------- -------- ---------- -------- -------- -------- Total from investment operations ......... 0.76 (5.53) 1.90 3.67 2.09 2.86 -------- -------- ---------- -------- -------- -------- Less distributions from: Net investment income ................. -- (0.26) (0.64) (0.33) (0.35) (0.33) Net realized gains .................... -- (1.41) (1.31) (1.30) (1.44) (0.93) -------- -------- ---------- -------- -------- -------- Total distributions ...................... -- (1.67) (1.95) (1.63) (1.79) (1.26) -------- -------- ---------- -------- -------- -------- Redemption fees(d) ....................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- ---------- -------- -------- -------- Net asset value, end of period ........... $ 15.26 $ 14.50 $ 21.70 $ 21.75 $ 19.71 $ 19.41 ======== ======== ========== ======== ======== ======== Total return(f) .......................... 5.24% (25.55)% 8.73% 18.94% 10.85% 16.27% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ..... 1.23% 1.11% 1.14% 1.15% 1.20% 1.17% Expenses net of expense reduction(h) ..... 1.22% 1.11% 1.14% 1.15% 1.20% 1.17% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ..... 1.13% 1.11% 1.13% 1.13% 1.16% 1.16% Expenses net of expense reduction ..... 1.12% 1.11% 1.13% 1.13% 1.16% 1.16% Net investment income .................... 1.10%(c) 1.67% 2.24% 1.45% 1.69% 1.66% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $961,625 $883,955 $1,290,899 $993,364 $794,789 $692,523 Portfolio turnover rate .................. 13.33% 25.52% 26.25% 23.64% 20.98% 37.61%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.78%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual Quest Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ---------------------------------------------------- CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 14.19 $ 21.24 $ 21.32 $ 19.34 $ 19.08 $ 17.54 ------- ------- ------- ------- ------- ------- Income from investment operations(a): Net investment income(b) .............. 0.03(c) 0.19 0.36 0.16 0.20 0.19 Net realized and unrealized gains (losses) ........................... 0.66 (5.72) 1.34 3.31 1.72 2.50 ------- ------- ------- ------- ------- ------- Total from investment operations ......... 0.69 (5.53) 1.70 3.47 1.92 2.69 ------- ------- ------- ------- ------- ------- Less distributions from: Net investment income ................. -- (0.11) (0.47) (0.19) (0.22) (0.22) Net realized gains .................... -- (1.41) (1.31) (1.30) (1.44) (0.93) ------- ------- ------- ------- ------- ------- Total distributions ...................... -- (1.52) (1.78) (1.49) (1.66) (1.15) ------- ------- ------- ------- ------- ------- Redemption fees(d)........................ -- --(e) --(e) --(e) --(e) --(e) ------- ------- ------- ------- ------- ------- Net asset value, end of period ........... $ 14.88 $ 14.19 $ 21.24 $ 21.32 $ 19.34 $ 19.08 ======= ======= ======= ======= ======= ======= Total return(f)........................... 4.86% (26.09)% 8.04% 18.16% 10.12% 15.46% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ..... 1.92% 1.81% 1.80% 1.82% 1.85% 1.82% Expenses net of expense reduction(h) ..... 1.91% 1.81% 1.80% 1.82% 1.85% 1.82% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ..... 1.82% 1.81% 1.79% 1.80% 1.81% 1.81% Expenses net of expense reduction ..... 1.81% 1.81% 1.79% 1.80% 1.81% 1.81% Net investment income .................... 0.41%(c) 0.97% 1.58% 0.78% 1.04% 1.01% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $37,505 $41,704 $70,266 $74,470 $69,847 $67,714 Portfolio turnover rate .................. 13.33% 25.52% 26.25% 23.64% 20.98% 37.61%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.09%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual Quest Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 --------------------------------------------------------- CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- --------- --------- --------- --------- --------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 14.38 $ 21.50 $ 21.58 $ 19.58 $ 19.30 $ 17.72 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.03(c) 0.19 0.36 0.16 0.20 0.19 Net realized and unrealized gains (losses) ........................... 0.67 (5.78) 1.36 3.34 1.74 2.52 -------- -------- -------- -------- -------- -------- Total from investment operations ......... 0.70 (5.59) 1.72 3.50 1.94 2.71 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ................. -- (0.12) (0.49) (0.20) (0.22) (0.20) Net realized gains .................... -- (1.41) (1.31) (1.30) (1.44) (0.93) -------- -------- -------- -------- -------- -------- Total distributions ...................... -- (1.53) (1.80) (1.50) (1.66) (1.13) -------- -------- -------- -------- -------- -------- Redemption fees(d) ....................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- -------- Net asset value, end of period ........... $ 15.08 $ 14.38 $ 21.50 $ 21.58 $ 19.58 $ 19.30 ======== ======== ======== ======== ======== ======== Total return(f) .......................... 4.87% (26.06)% 8.02% 18.16% 10.08% 15.52% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ..... 1.92% 1.80% 1.80% 1.83% 1.85% 1.82% Expenses net of expense reduction(h) ..... 1.91% 1.80% 1.80% 1.83% 1.85% 1.82% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ..... 1.82% 1.80% 1.79% 1.81% 1.81% 1.81% Expenses net of expense reduction ..... 1.81% 1.80% 1.79% 1.81% 1.81% 1.81% Net investment income .................... 0.41%(c) 0.98% 1.58% 0.77% 1.04% 1.01% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $350,925 $337,583 $504,802 $420,806 $336,786 $311,071 Portfolio turnover rate .................. 13.33% 25.52% 26.25% 23.64% 20.98% 37.61%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.09%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 19 Mutual Quest Fund FINANCIAL HIGHLIGHTS (CONTINUED)
PERIOD ENDED JUNE 30, 2009(a) CLASS R (UNAUDITED) - ------- ---------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ......................... $14.64 ------ Income from investment operations(b): Net investment income (loss)(c) ........................... 0.04 Net realized and unrealized gains (losses) ................ 0.56 ------ Total from investment operations ............................. 0.60 ------ Net asset value, end of period ............................... $15.24 ====== Total return(d) .............................................. 4.10% RATIOS TO AVERAGE NET ASSETS(e) Expenses before expense reduction(f) ......................... 1.42% Expenses net of expense reduction(f) ......................... 1.41% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ......................... 1.32% Expenses net of expense reduction ......................... 1.31% Net investment income ........................................ 0.91%(g) SUPPLEMENTAL DATA Net assets, end of period (000's) ............................ $ 5 Portfolio turnover rate ...................................... 13.33%
(a) For the period May 1, 2009 (effective date) to June 30, 2009. (b) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (c) Based on average daily shares outstanding. (d) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (e) Ratios are annualized for periods less than one year. (f) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (g) Net investment income includes a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.60%. See Note 8. The accompanying notes are an integral part of these financial statements. 20 | Semiannual Report Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- ---------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 66.8% AIRLINES 0.1% (a) ACE Aviation Holdings Inc., A ................... Canada 1,217,946 $ 5,550,637 (a) Delta Air Lines Inc. ............................ United States 2,335 13,520 (a, b) Northwest Airlines Corp., Contingent Distribution ................................. United States 28,232,000 17,786 ---------------- 5,581,943 ---------------- AUTO COMPONENTS 0.1% (a, b, c) Collins & Aikman Products Co., Contingent Distribution ................................. United States 1,217,404 12,174 (a, b, c) Dana Holding Corp., Contingent Distribution ..... United States 13,598,000 -- (a, d) IACNA Investor LLC .............................. United States 180,986 1,810 (a, d, e) International Automotive Components Group Brazil LLC ................................... Brazil 2,363,058 2,115,978 (a, d, e) International Automotive Components Group Japan LLC .......................................... Japan 307,801 851,468 (a, d, e) International Automotive Components Group LLC ... Luxembourg 8,425,843 1,911,824 (a, d, e) International Automotive Components Group NA LLC, A ....................................... United States 5,182,488 197,453 ---------------- 5,090,707 ---------------- BEVERAGES 3.2% Brown-Forman Corp., A ........................... United States 79,200 3,651,912 Brown-Forman Corp., B ........................... United States 19,800 851,004 Carlsberg AS, B ................................. Denmark 250,882 16,089,146 (a) Dr. Pepper Snapple Group Inc. ................... United States 1,317,046 27,908,205 Fomento Economico Mexicano SAB de CV, ADR ....... Mexico 340,000 10,961,600 Lion Nathan Ltd. ................................ Australia 1,045,082 9,736,760 (f) Pernod Ricard SA ................................ France 1,239,406 78,001,602 ---------------- 147,200,229 ---------------- BUILDING PRODUCTS 0.1% (a) Armstrong World Industries Inc. ................. United States 142,220 2,345,208 (a) Owens Corning Inc. .............................. United States 279,965 3,577,953 ---------------- 5,923,161 ---------------- CAPITAL MARKETS 0.3% Man Group PLC ................................... United Kingdom 3,164,930 14,450,584 ---------------- CHEMICALS 0.2% (a, b, c) Dow Corning Corp., Contingent Distribution ...... United States 20,809,194 3,022,299 Sika AG ......................................... Switzerland 6,147 6,820,574 ---------------- 9,842,873 ---------------- COMMERCIAL BANKS 1.6% Barclays PLC .................................... United Kingdom 1,738,407 8,094,615 BNP Paribas SA .................................. France 417,157 27,061,081 (a, d, g) Elephant Capital Holdings Ltd. .................. Japan 27,946 -- (a, d, g) First Chicago Bancorp ........................... United States 659,105 1,662,343 (a) Guaranty Bancorp ................................ United States 1,735,639 3,315,071 (a) Intesa Sanpaolo SpA ............................. Italy 3,547,880 11,420,509 (a, d) NCB Warrant Holdings Ltd., A .................... Japan 129,974 -- Societe Generale, A ............................. France 203,330 11,089,639 SunTrust Banks Inc. ............................. United States 76,700 1,261,715 Svenska Handelsbanken AB, A ..................... Sweden 452,960 8,555,663 ---------------- 72,460,636 ----------------
Semiannual Report | 21 Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- ---------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL SERVICES & SUPPLIES 0.2% (a) Comdisco Holding Co. Inc. ....................... United States 997 $ 7,278 (a, b) Comdisco Holding Co. Inc., Contingent Distribution ................................. United States 40,189,000 -- (a) Insun ENT Co. Ltd. .............................. South Korea 1,448,946 7,853,951 ---------------- 7,861,229 ---------------- COMPUTERS & PERIPHERALS 1.3% (a, d, g) DecisionOne Corp. ............................... United States 1,008,199 1,663,529 (a, d, g) DecisionOne Corp., wts., 6/08/17 ................ United States 553,576 -- (a) Dell Inc. ....................................... United States 563,099 7,731,349 (a) Sun Microsystems Inc. ........................... United States 5,136,250 47,356,225 ---------------- 56,751,103 ---------------- CONSUMER FINANCE 0.2% (a, d) Cerberus CG Investor I LLC ...................... United States 7,519,799 1,428,762 (a, d) Cerberus CG Investor II LLC ..................... United States 7,519,799 1,428,762 (a, d) Cerberus CG Investor III LLC .................... United States 3,759,899 714,381 (a, d) Cerberus FIM Investors Holdco LLC ............... United States 16,133,491 1,174,518 (a, g) White River Capital Inc. ........................ United States 549,751 5,126,428 ---------------- 9,872,851 ---------------- DIVERSIFIED FINANCIAL SERVICES 0.6% Deutsche Boerse AG .............................. Germany 254,247 19,713,228 (a) Fortis .......................................... Belgium 2,540,000 8,657,128 (a, b) Marconi Corp., Contingent Distribution .......... United Kingdom 34,293,500 -- ---------------- 28,370,356 ---------------- DIVERSIFIED TELECOMMUNICATION SERVICES 1.5% (a, d) AboveNet Inc. ................................... United States 402,522 32,596,232 (a, d) AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ...................... United States 510 30,615 (a, d) AboveNet Inc., wts., 9/08/10 .................... United States 16,099 925,692 (a, b, c) Global Crossing Holdings Ltd., Contingent Distribution ................................. United States 49,411,586 -- (f) Koninklijke KPN NV .............................. Netherlands 2,351,320 32,316,726 ---------------- 65,869,265 ---------------- ELECTRIC UTILITIES 0.9% E.ON AG ......................................... Germany 1,192,640 42,204,667 ---------------- ENERGY EQUIPMENT & SERVICES 3.6% (h) Bourbon SA ...................................... France 637,519 24,979,047 (a) BW Offshore Ltd. ................................ Norway 2,813,120 3,498,416 (a) Pride International Inc. ........................ United States 1,042,880 26,134,573 Seadrill Ltd. ................................... Bermuda 4,055,672 57,876,026 (a) Transocean Ltd. ................................. United States 677,655 50,342,990 ---------------- 162,831,052 ---------------- FOOD & STAPLES RETAILING 1.1% Carrefour SA .................................... France 1,178,243 50,272,205 ----------------
22 | Semiannual Report Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- ---------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) FOOD PRODUCTS 8.8% Cadbury PLC ..................................... United Kingdom 5,037,596 $ 42,934,994 CSM NV .......................................... Netherlands 2,000,055 29,511,517 (f) Danone .......................................... France 2,906,708 143,427,062 Kraft Foods Inc., A ............................. United States 435,256 11,029,387 (a) Lighthouse Caledonia ASA ........................ Norway 416,331 18,122 Lotte Confectionary Co. Ltd. .................... South Korea 30,405 23,850,800 (a, h) Marine Harvest .................................. Norway 48,980,183 32,892,535 Nestle SA ....................................... Switzerland 2,410,451 90,749,522 Nong Shim Co. Ltd. .............................. South Korea 81,743 14,683,987 (a) Premier Foods PLC ............................... United Kingdom 14,034,206 8,543,737 ---------------- 397,641,663 ---------------- HEALTH CARE PROVIDERS & SERVICES 1.5% (a) Kindred Healthcare Inc. ......................... United States 1,456,113 18,012,118 Rhoen-Klinikum AG ............................... Germany 2,314,092 51,088,036 ---------------- 69,100,154 ---------------- HOTELS, RESTAURANTS & LEISURE 0.0%i (a) Trump Entertainment Resorts Inc. ................ United States 316,917 53,876 ---------------- INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 0.0%(i) (a) NRG Energy Inc. ................................. United States 13,111 340,362 ---------------- INDUSTRIAL CONGLOMERATES 2.1% Keppel Corp. Ltd. ............................... Singapore 5,486,488 26,131,543 (e) Orkla ASA ....................................... Norway 9,599,083 69,685,084 ---------------- 95,816,627 ---------------- INSURANCE 6.7% ACE Ltd. ........................................ United States 96,280 4,258,464 (a) Alleghany Corp. ................................. United States 149,605 40,542,955 (a) Berkshire Hathaway Inc., A ...................... United States 468 42,120,000 (a) Berkshire Hathaway Inc., B ...................... United States 17,944 51,960,979 (a, d, g) Imagine Group Holdings Ltd. ..................... Bermuda 2,814,856 25,642,494 Old Republic International Corp. ................ United States 1,096,314 10,798,693 (a, d) Olympus Re Holdings Ltd. ........................ United States 97,300 212,639 (a, d) Symetra Financial ............................... United States 3,434,760 50,353,582 White Mountains Insurance Group Ltd. ............ United States 346,730 79,369,964 ---------------- 305,259,770 ---------------- MACHINERY 2.2% Kone OYJ, B ..................................... Finland 2,877,200 88,096,296 (a, d, e, g) Motor Coach Industries International Inc. ....... United States 4,285 5,572,642 NACCO Industries Inc., A ........................ United States 172,254 4,947,135 ---------------- 98,616,073 ---------------- MEDIA 0.4% (a) Adelphia Recovery Trust ......................... United States 38,254,708 956,368 (a, b) Adelphia Recovery Trust, Arahova Contingent Value Vehicle, Contingent Distribution ............. United States 4,899,492 930,903
Semiannual Report | 23 Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- ---------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MEDIA (CONTINUED) (a, b) Century Communications Corp., Contingent Distribution .................................... United States 13,497,000 $ -- CJ CGV Co. Ltd. ................................. South Korea 574,910 9,741,180 (a, c) TVMAX Holdings Inc. ............................. United States 111,391 -- Virgin Media Inc. ............................... United Kingdom 937,859 8,768,982 ---------------- 20,397,433 ---------------- MULTI-UTILITIES 0.4% (f) GDF Suez ........................................ France 503,432 18,740,259 (a, b) NorthWestern Corp., Contingent Distribution ..... United States 9,300,000 -- ---------------- 18,740,259 ---------------- MULTILINE RETAIL 1.0% Jelmoli Holding AG .............................. Switzerland 121,995 44,223,047 ---------------- OIL, GAS & CONSUMABLE FUELS 2.5% (f) BP PLC .......................................... United Kingdom 3,817,400 30,010,424 BP PLC, ADR ..................................... United Kingdom 193,700 9,235,616 Eni SpA ......................................... Italy 523,870 12,381,045 (f) Royal Dutch Shell PLC, A ........................ United Kingdom 1,000,000 24,966,281 Total SA, B ..................................... France 665,472 35,916,889 ---------------- 112,510,255 ---------------- PAPER & FOREST PRODUCTS 0.5% Weyerhaeuser Co. ................................ United States 686,788 20,898,959 ---------------- PERSONAL PRODUCTS 0.2% L'Oreal SA ...................................... France 150,620 11,254,856 ---------------- PHARMACEUTICALS 7.6% Schering-Plough Corp. ........................... United States 6,557,530 164,725,154 (a) Valeant Pharmaceuticals International ........... United States 768,825 19,774,179 Wyeth ........................................... United States 3,498,150 158,781,028 ---------------- 343,280,361 ---------------- REAL ESTATE INVESTMENT TRUSTS (REITS) 1.8% Alexander's Inc. ................................ United States 108,590 29,275,864 Link REIT ....................................... Hong Kong 15,207,140 32,455,399 Ventas Inc. ..................................... United States 669,525 19,992,016 ---------------- 81,723,279 ---------------- REAL ESTATE MANAGEMENT & DEVELOPMENT 1.6% (a, c) Canary Wharf Group PLC .......................... United Kingdom 8,298,072 23,893,158 Swire Pacific Ltd., A ........................... Hong Kong 3,620,800 36,535,512 Swire Pacific Ltd., B ........................... Hong Kong 5,292,600 10,134,606 ---------------- 70,563,276 ---------------- SOFTWARE 0.9% Microsoft Corp. ................................. United States 1,672,254 39,749,478 ---------------- THRIFTS & MORTGAGE FINANCE 0.0%(i) (a, g) Imperial Capital Bancorp Inc. ................... United States 445,796 160,487 ----------------
24 | Semiannual Report Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- ---------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 13.0% Altria Group Inc. ................................ United States 3,759,637 $ 61,620,450 British American Tobacco PLC ..................... United Kingdom 4,277,004 117,731,834 Imperial Tobacco Group PLC ....................... United Kingdom 2,263,678 58,773,284 Japan Tobacco Inc. ............................... Japan 9,642 30,218,804 KT&G Corp. ....................................... South Korea 737,519 41,654,666 (f) Lorillard Inc. ................................... United States 2,179,680 147,716,914 Philip Morris International Inc. ................. United States 1,488,277 64,918,643 Reynolds American Inc. ........................... United States 1,781,680 68,808,482 ---------------- 591,443,077 ---------------- TRADING COMPANIES & DISTRIBUTORS 0.6% (a) Kloeckner & Co. SE ............................... Germany 1,209,391 25,698,823 ---------------- TRANSPORTATION INFRASTRUCTURE 0.0%(i) (a) Groupe Eurotunnel SA ............................. France 17,485 99,079 (a) Groupe Eurotunnel SA, wts., 12/30/11 ............. France 1,861,027 294,961 ---------------- 394,040 ---------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,692,899,741) 3,032,449,016 ---------------- PREFERRED STOCKS 0.7% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(i) (a, d) PTV Inc., 10.00%, pfd., A ........................ United Kingdom 92,938 22,305 ---------------- MACHINERY 0.7% (a, d, e, g) Motor Coach Industries International Inc., pfd. .. United States 30,746 30,746,000 ---------------- TOTAL PREFERRED STOCKS (COST $30,804,551) ........ 30,768,305 ----------------
PRINCIPAL AMOUNT(j) ---------------- CORPORATE BONDS & NOTES 3.2% American General Finance Corp., 5.85%, 6/01/13 ................................... United States 504,000 289,424 senior note, J, 6.90%, 12/15/17 .................. United States 7,058,000 3,826,812 (k) BP Capital Markets PLC, FRN, 1.614%, 3/17/11 ..... United Kingdom 30,000,000 30,371,400 (k) Calpine Corp., Exit Term Loan, FRN, 4.095%, 3/29/14 ....................................... United States 15,339,064 13,617,683 (d, l) Cerberus CG Investor I LLC, 12.00%, 7/31/14 ...... United States 6,600,000 1,254,000 (d, l) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ..... United States 6,600,000 1,254,000 (d, l) Cerberus CG Investor III LLC, 12.00%, 7/31/14 .... United States 3,300,000 627,000 (d, l) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ...................................... United States 47,747,515 3,473,679 (g) DecisionOne Corp., (d) senior secured note, 15.00%, 11/30/13 ......... United States 1,324,103 1,478,361 (c) Term Loan B, 15.00%, 8/29/13 .................. United States 232,502 259,589 Groupe Eurotunnel SA, cvt., sub. bond, NRS I, T2, 3.00%, 7/28/09 ............................... France 31,400 EUR 35,233 T2, 3.00%, 7/28/09 ............................... France 24,416 GBP 42,181 T3, 3.00%, 7/28/10 ............................... France 9,114,500 EUR 10,227,199 T3, 3.00%, 7/28/10 ............................... France 5,276,020 GBP 9,114,945
Semiannual Report | 25 Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(j) VALUE -------------- ---------------- ---------------- CORPORATE BONDS & NOTES (CONTINUED) (m) Indianapolis Downs LLC, 144A, senior secured note, 11.00%, 11/01/12 ........ United States 2,950,000 $ 2,301,000 (n) senior secured sub. note, PIK, 15.50%, 11/01/13 .................................. United States 12,577,416 7,043,353 (c, e, k) International Automotive Components Group NA Inc., Revolver, FRN, 5.75%, 1/18/14 .......... United States 1,027,724 1,027,724 (d, e, l) International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............................... United States 1,560,200 707,914 (d, e, k, o) Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ...................................... United States 18,093,040 17,361,233 (d, e, k, o) Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 .............. United States 2,869,673 4,999,203 (k, m) Roche Holdings Inc., 144A, FRN, 1.661%, 2/25/10 ...................................... Switzerland 32,901,000 32,926,663 Seadrill Ltd., cvt., senior note, 3.625%, 11/08/12 ..................................... Bermuda 5,000,000 3,930,000 (c, n) TVMAX Holdings Inc., PIK, 11.50%, 9/30/09 .............................. United States 601,205 168,822 14.00%, 9/30/09 .............................. United States 896,095 242,045 ---------------- TOTAL CORPORATE BONDS & NOTES (COST $245,777,325) .......................... 146,579,463 ---------------- CORPORATE BONDS & NOTES IN REORGANIZATION 0.3% (k, l, p) Charter Communications Operating LLC, Term Loan B, FRN, 6.25%, 3/06/14 ....................... United States 11,594,199 10,514,489 (c, l) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ...................................... United States 40,000 200 (l) Trump Entertainment Resorts Inc., 8.50%, 6/01/15 ...................................... United States 13,553,108 1,744,963 ---------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $22,089,935) ........................... 12,259,652 ---------------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $2,991,571,552) ........................ 3,222,056,436 ---------------- SHORT TERM INVESTMENTS 32.1% U.S. GOVERNMENT AND AGENCY SECURITIES 31.9% (q) FHLB, 7/01/09 ................................... United States 3,700,000 3,700,000 (q) U.S. Treasury Bills, 7/02/09 ...................................... United States 69,000,000 68,999,931 7/09/09 ...................................... United States 100,000,000 99,998,100 7/16/09 ...................................... United States 97,000,000 96,996,120 7/23/09 ...................................... United States 100,000,000 99,993,300 7/30/09 ...................................... United States 100,000,000 99,987,800 8/06/09 ...................................... United States 125,000,000 124,981,875 8/13/09 ...................................... United States 125,000,000 124,978,375 (r) 8/20/09 ...................................... United States 125,000,000 124,974,500 8/27/09 ...................................... United States 125,000,000 124,972,875 (r) 9/03/09 ...................................... United States 170,000,000 169,959,200 9/10/09 ...................................... United States 100,000,000 99,970,000 (r) 9/17/09 ...................................... United States 50,000,000 49,981,600 9/24/09 - 12/1709 ............................ United States 160,000,000 159,871,640 ---------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $1,448,914,834) ........................ 1,449,365,316 ---------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $4,440,486,386) ........................ 4,671,421,752 ----------------
26 | Semiannual Report Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY SHARES VALUE -------------- ---------------- ---------------- (s) INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.2% MONEY MARKET FUNDS (COST $8,239,656) 0.2% (t) Bank of New York Institutional Cash Reserve Fund, 0.12%............................................ United States 8,239,656 $ 8,157,260 ---------------- TOTAL INVESTMENTS (COST $4,448,726,042) 103.1%...... 4,679,579,012 OPTIONS WRITTEN (0.5)%.............................. (20,777,623) SECURITIES SOLD SHORT (3.5)%........................ (157,419,375) OTHER ASSETS, LESS LIABILITIES 0.9%................. 40,017,675 ---------------- NET ASSETS 100.0%................................... $ 4,541,399,689 ================
CONTRACTS ---------------- (u) OPTIONS WRITTEN 0.5% CALL OPTIONS 0.5% BEVERAGES 0.1% Pernod Ricard SA, Sep. 37.73 Calls, 9/18/09 ........ France 380,000 $ 4,170,758 ---------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(i) Koninklijke KPN NV, Sep. 10 Calls, 9/18/09 ......... Netherlands 1,500,000 525,975 ---------------- FOOD PRODUCTS 0.1% Danone, Sep. 32.08 Calls, 9/18/09 .................. France 450,000 2,512,057 ---------------- MULTI-UTILITIES 0.1% GDF Suez, Dec. 26 Calls, 12/19/09 .................. France 485,000 2,270,167 ---------------- OIL, GAS & CONSUMABLE FUELS 0.1% BP PLC, Sep. 4.40 Calls, 9/18/09 ................... United Kingdom 3,323,000 2,556,056 Royal Dutch Shell PLC, Sep. 16 Calls, 9/18/09 ...... United Kingdom 1,000,000 2,875,330 ---------------- 5,431,386 ---------------- TOBACCO 0.1% Lorillard Inc., Sep. 60 Calls, 9/19/09 ............. United States 6,744 5,867,280 ---------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $14,727,514).................. $ 20,777,623 ----------------
SHARES ---------------- (v) SECURITIES SOLD SHORT 3.5% PHARMACEUTICALS 3.5% Merck & Co. Inc. ................................... United States 3,781,728 $ 105,737,115 Pfizer Inc. ........................................ United States 3,445,484 51,682,260 ---------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $139,529,566) ................................... $ 157,419,375 ----------------
Semiannual Report | 27 Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED) (a) Non-income producing. (b) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the aggregate value of these securities was $28,626,011, representing 0.63% of net assets. (d) See Note 9 regarding restricted securities. (e) See Note 13 regarding other considerations. (f) A portion or all of the security is held in connection with written option contracts open at period end. (g) See Note 12 regarding holdings of 5% voting securities. (h) A portion or all of the security is on loan at June 30, 2009. See Note 1(h). (i) Rounds to less than 0.1% of net assets. (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) The coupon rate shown represents the rate at period end. (l) See Note 8 regarding credit risk and defaulted securities. (m) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Trustees. At June 30, 2009, the aggregate value of these securities was $42,271,016, representing 0.93% of net assets. (n) Income may be received in additional securities and/or cash. (o) See Note 1(g) regarding special purpose entities. (p) A portion or all of the security purchased on a delayed delivery basis. See Note 1(c). (q) The security is traded on a discount basis with no stated coupon rate. (r) Security or a portion of the security has been segregated as collateral for securities sold short, open forward contracts, and open option contracts. At June 30, 2009, the value of securities and/or cash pledged amounted to $251,095,428. (s) See Note 1(h) regarding securities on loan. (t) The rate shown is the annualized seven-day yield at period end. (u) See Note 1(d) regarding written options. (v) See Note 1(f) regarding securities sold short. At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(d).
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------------- ----------- ---------- ------------ ------------ South Korean Won ........ BANT Sell 68,103,211,875 $51,874,858 7/08/09 $ -- $ (1,574,639) South Korean Won ........ BBU Sell 8,281,250,000 6,250,000 7/08/09 -- (249,380) South Korean Won ........ BANT Buy 1,900,000,000 1,487,862 7/08/09 3,316 -- British Pound ........... SSBT Sell 30,005,477 45,969,078 7/13/09 -- (3,399,674) British Pound ........... BANT Sell 11,781,205 17,104,922 7/13/09 -- (2,278,985) British Pound ........... HSBC Sell 5,650,000 8,289,904 7/13/09 -- (1,006,181) British Pound ........... BBU Sell 950,000 1,436,828 7/13/09 -- (126,231) British Pound ........... SSBT Buy 1,475,000 2,093,291 7/13/09 333,563 -- British Pound ........... BANT Buy 540,000 777,519 7/13/09 110,956 -- British Pound ........... HSBC Buy 1,000,000 1,429,000 7/13/09 216,325 -- Euro .................... BBU Sell 12,900,000 16,679,700 7/27/09 -- (1,414,143) Euro .................... BANT Sell 13,100,000 17,011,783 7/27/09 -- (1,362,585) Euro .................... DBFX Sell 6,850,000 9,389,172 7/27/09 -- (218,799) Euro .................... SSBT Sell 1,918,234 2,543,751 7/27/09 -- (146,809) Euro .................... HSBC Sell 3,150,000 4,307,780 7/27/09 -- (110,484) Swiss Franc ............. SSBT Sell 40,289,320 34,895,535 8/10/09 -- (2,192,830)
28 | Semiannual Report Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------------- ----------- ---------- ------------ ------------ Swiss Franc ............. HSBC Sell 30,116,911 $26,007,095 8/10/09 $ -- $ (1,717,050) Swiss Franc ............. BANT Sell 31,289,880 27,114,376 8/10/09 -- (1,689,548) Swiss Franc ............. BBU Sell 753,324 680,000 8/10/09 -- (13,473) Swiss Franc ............. BANT Buy 3,873,744 3,360,000 8/10/09 205,978 -- Swiss Franc ............. SSBT Buy 6,128,200 5,389,967 8/10/09 251,353 -- Swiss Franc ............. DBFX Sell 2,036,357 1,890,000 8/10/09 15,430 -- British Pound ........... BBU Sell 52,230,309 78,640,825 8/12/09 -- (7,291,124) Euro .................... BANT Sell 32,520,000 42,187,088 8/13/09 -- (3,424,583) Euro .................... SSBT Sell 34,672,788 45,645,522 8/13/09 -- (2,985,590) Euro .................... BBU Sell 8,800,000 11,749,936 8/13/09 -- (592,705) Norwegian Krone ......... HAND Sell 562,536,978 86,393,648 8/19/09 -- (937,468) Norwegian Krone ......... HAND Buy 7,942,319 1,210,000 8/19/09 23,006 -- Norwegian Krone ......... BBU Sell 17,242,826 2,680,000 8/19/09 3,136 -- Norwegian Krone ......... DBFX Sell 25,842,914 4,090,000 8/19/09 78,014 -- Canadian Dollar ......... SSBT Sell 7,093,247 5,720,361 8/31/09 -- (381,319) Canadian Dollar ......... BANT Sell 919,600 735,886 8/31/09 -- (55,163) Canadian Dollar ......... SSBT Buy 2,050,000 1,649,816 8/31/09 113,614 -- Euro .................... SSBT Sell 29,110,000 37,143,526 8/31/09 -- (3,683,193) Euro .................... BANT Sell 9,625,000 12,988,769 8/31/09 -- (510,275) Euro .................... HSBC Sell 7,540,000 10,165,178 8/31/09 -- (409,658) Euro .................... BBU Sell 5,355,000 7,294,026 8/31/09 -- (216,352) Euro .................... DBFX Sell 640,000 915,552 8/31/09 17,953 -- British Pound ........... SSBT Sell 50,500,000 71,223,180 9/10/09 -- (11,856,787) British Pound ........... BBU Sell 29,933,840 44,391,884 9/14/09 -- (4,853,216) British Pound ........... BANT Sell 1,350,000 1,942,893 9/14/09 -- (278,034) British Pound ........... SSBT Sell 840,000 1,248,639 9/14/09 -- (133,271) British Pound ........... AESX Buy 1,920,000 3,128,319 9/14/09 30,333 -- British Pound ........... SSBT Buy 401,400 660,046 9/14/09 1,286 -- Euro .................... BANT Sell 56,650,000 72,447,821 9/14/09 -- (6,998,116) Euro .................... BBU Sell 55,000,000 74,851,425 9/14/09 -- (2,280,553) Euro .................... HSBC Sell 1,710,000 2,203,848 9/14/09 -- (194,255) Euro .................... SSBT Sell 1,413,394 1,815,830 9/14/09 -- (166,313) Euro .................... AESX Buy 1,410,000 1,941,937 9/14/09 35,447 -- Euro .................... BANT Buy 5,640,000 7,775,473 9/14/09 134,061 -- Euro .................... BBU Buy 7,050,000 9,711,904 9/14/09 175,013 -- Euro .................... SSBT Buy 2,996,792 4,178,398 9/14/09 24,303 -- Swedish Krona ........... HAND Sell 61,451,180 7,226,788 9/16/09 -- (735,672) Swedish Krona ........... SSBT Sell 1,600,000 189,870 9/16/09 -- (17,448) Swedish Krona ........... BANT Sell 2,200,000 274,468 9/16/09 -- (10,594) Swedish Krona ........... HAND Buy 4,113,437 520,721 9/16/09 12,272 -- Australian Dollar ....... HSBC Sell 2,770,516 2,132,302 9/17/09 -- (85,292) Australian Dollar ....... SSBT Sell 6,905,351 5,498,792 9/17/09 -- (30,016) Australian Dollar ....... BANT Sell 2,563,176 2,026,012 9/17/09 -- (26,616) Australian Dollar ....... SSBT Buy 45,800 36,451 9/17/09 208 -- Singapore Dollar ........ SSBT Sell 12,739,574 8,403,280 9/24/09 -- (386,048) Singapore Dollar ........ BANT Sell 4,550,988 3,053,458 9/24/09 -- (86,374) Singapore Dollar ........ HSBC Sell 2,453,899 1,665,569 9/24/09 -- (27,433) Singapore Dollar ........ SSBT Buy 1,152,162 786,030 9/24/09 8,874 --
Semiannual Report | 29 Mutual Quest Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------------- ----------- ---------- ------------ ------------ Singapore Dollar ........ BBU Sell 1,293,975 $ 900,000 9/24/09 $ 7,257 $ -- Euro .................... BBU Sell 50,000,000 68,036,000 10/13/09 -- (2,078,060) Japanese Yen ............ SSBT Sell 1,712,776,837 17,335,798 10/20/09 -- (465,318) Japanese Yen ............ BBU Sell 77,036,060 790,000 10/20/09 -- (10,646) Japanese Yen ............ HSBC Sell 146,515,640 1,520,000 10/20/09 -- (2,756) Japanese Yen ............ SSBT Buy 66,000,000 670,432 10/20/09 15,515 -- Japanese Yen ............ BANT Buy 38,138,100 385,000 10/20/09 11,374 -- Japanese Yen ............ BANT Sell 34,870,275 365,000 10/20/09 2,589 -- Japanese Yen ............ DBFX Sell 73,893,300 780,000 10/20/09 12,017 -- Japanese Yen ............ AESX Sell 150,628,051 1,570,000 10/20/09 4,503 -- Danish Krone ............ HAND Sell 71,494,015 12,446,323 10/23/09 -- (996,132) Danish Krone ............ BANT Sell 12,991,765 2,300,299 10/23/09 -- (142,440) Danish Krone ............ BBU Sell 5,751,760 1,050,000 10/23/09 -- (31,458) Danish Krone ............ BBU Buy 1,745,370 330,000 10/23/09 -- (1,832) Danish Krone ............ HAND Buy 6,830,314 1,198,360 10/23/09 85,890 -- Euro .................... BANT Sell 30,243,156 38,953,184 11/13/09 -- (3,454,979) Euro .................... SSBT Sell 58,125,630 78,670,033 11/13/09 -- (2,836,053) Euro .................... HSBC Sell 3,270,000 4,367,591 11/13/09 -- (217,734) Euro .................... BBU Sell 52,000,000 72,259,200 11/30/09 -- (656,107) Euro .................... BONY Sell 12,394,994 17,205,491 11/30/09 -- (174,985) --------- ------------ Unrealized appreciation (depreciation) ................................................. 1,933,586 (77,222,779) --------- ------------ Net unrealized appreciation (depreciation) .......................................... $(75,289,193) ============
See Abbreviations on page 51. The accompanying notes are an integral part of these financial statements. 30 | Semiannual Report Mutual Quest Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers .................................. $4,341,290,665 Cost - Non-controlled affiliated issuers (Note 12) ........... 107,435,377 -------------- Total cost of investments .................................... $4,448,726,042 ============== Value - Unaffiliated issuers ................................. $4,607,267,139 Value - Non-controlled affiliated issuers (Note 12) .......... 72,311,873 -------------- Total value of investments (includes securities loaned in the amount of $7,796,380) ..................................... 4,679,579,012 Cash ............................................................ 2,240,879 Cash on deposit with brokers .................................... 156,901,939 Foreign currency, at value (cost $9,970,400) .................... 9,969,067 Receivables: Investment securities sold ................................... 4,978,993 Capital shares sold .......................................... 3,275,126 Dividends and interest ....................................... 6,130,459 Unrealized appreciation on forward exchange contracts ........... 1,933,586 Other assets .................................................... 6,083 -------------- Total assets .............................................. 4,865,015,144 -------------- Liabilities: Payables: Investment securities purchased .............................. 50,666,154 Capital shares redeemed ...................................... 4,473,228 Affiliates ................................................... 3,877,104 Options written, at value (premiums received $14,727,514) ....... 20,777,623 Securities sold short, at value (proceeds $139,529,566) ......... 157,419,375 Payable upon return of securities loaned ........................ 8,239,656 Unrealized depreciation on forward exchange contracts ........... 77,222,779 Accrued expenses and other liabilities .......................... 939,536 -------------- Total liabilities ......................................... 323,615,455 -------------- Net assets, at value ................................... $4,541,399,689 ============== Net assets consist of: Paid-in capital ................................................. $4,387,452,564 Undistributed net investment income ............................. 25,427,108 Net unrealized appreciation (depreciation) ...................... 131,623,864 Accumulated net realized gain (loss) ............................ (3,103,847) -------------- Net assets, at value ................................... $4,541,399,689 ==============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 31 Mutual Quest Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ................................................... $3,191,339,544 -------------- Shares outstanding ..................................................... 207,535,592 -------------- Net asset value and maximum offering price per share ................... $ 15.38 -------------- CLASS A: Net assets, at value ................................................... $ 961,625,213 -------------- Shares outstanding ..................................................... 63,027,709 -------------- Net asset value per share(a) ........................................... $ 15.26 -------------- Maximum offering price per share (net asset value per share / 94.25%) .. $ 16.19 -------------- CLASS B: Net assets, at value ................................................... $ 37,504,673 -------------- Shares outstanding ..................................................... 2,519,940 -------------- Net asset value and maximum offering price per share(a) ................ $ 14.88 -------------- CLASS C: Net assets, at value ................................................... $ 350,925,048 -------------- Shares outstanding ..................................................... 23,273,898 -------------- Net asset value and maximum offering price per share(a) ................ $ 15.08 -------------- CLASS R: Net assets, at value ................................................... $ 5,211 -------------- Shares outstanding ..................................................... 342 -------------- Net asset value and maximum offering price per share ................... $ 15.24 --------------
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. 32 | Semiannual Report Mutual Quest Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends: (net of foreign taxes of $4,233,073) ................................... $ 54,064,783 Interest: Unaffiliated issuers ........................................................... 10,670,163 Reserve for uncollectible interest (Note 8) .................................... (15,465,651) Non-controlled affiliated issuers (Note 12) .................................... 85,266 Income from securities loaned ..................................................... 61,412 ------------ Total investment income ..................................................... 49,415,973 ------------ Expenses: Management fees (Note 3a) ......................................................... 12,799,644 Administrative fees (Note 3b) ..................................................... 1,633,706 Distribution fees: (Note 3c) Class A ........................................................................ 1,375,198 Class B ........................................................................ 190,137 Class C ........................................................................ 1,646,273 Class R ........................................................................ 4 Transfer agent fees (Note 3e) ..................................................... 2,012,414 Custodian fees (Note 4) ........................................................... 244,891 Reports to shareholders ........................................................... 141,590 Registration and filing fees ...................................................... 98,766 Professional fees ................................................................. 343,272 Trustees' fees and expenses ....................................................... 92,433 Dividends on securities sold short ................................................ 2,032,781 Other ............................................................................. 138,539 ------------ Total expenses .............................................................. 22,749,648 Expense reductions (Note 4) ................................................. (107,668) ------------ Net expenses ............................................................. 22,641,980 ------------ Net investment income ................................................. 26,773,993 ------------ Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ........................................................ (17,345,203) Non-controlled affiliated issuers (Note 12) ................................. (343,994) Written options ................................................................ 10,441,194 Foreign currency transactions .................................................. 50,747,603 Securities sold short .......................................................... (2,624,010) ------------ Net realized gain (loss) ................................................. 40,875,590 ------------ Net change in unrealized appreciation (depreciation) on: Investments .................................................................... 249,935,340 Translation of other assets and liabilities denominated in foreign currencies .. (91,880,811) ------------ Net change in unrealized appreciation (depreciation) ..................... 158,054,529 ------------ Net realized and unrealized gain (loss) .............................................. 198,930,119 ------------ Net increase (decrease) in net assets resulting from operations ...................... $225,704,112 ============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 33 Mutual Quest Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED JUNE 30, 2009 YEAR ENDED (UNAUDITED) DECEMBER 31, 2008 ---------------- ----------------- Increase (decrease) in net assets: Operations: Net investment income ..................................................... $ 26,773,993 $ 98,408,076 Net realized gain (loss) from investments, written options, securities sold short and foreign currency transactions ................ 40,875,590 325,690,431 Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ..................................................... 158,054,529 (1,971,227,628) -------------- --------------- Net increase (decrease) in net assets resulting from operations ..... 225,704,112 (1,547,129,121) -------------- --------------- Distributions to shareholders from: Net investment income: Class Z ................................................................ -- (61,395,078) Class A ................................................................ -- (14,205,288) Class B ................................................................ -- (308,286) Class C ................................................................ -- (2,613,022) Net realized gains: Class Z ................................................................ -- (269,629,983) Class A ................................................................ -- (76,838,699) Class B ................................................................ -- (3,820,054) Class C ................................................................ -- (30,141,995) -------------- --------------- Total distributions to shareholders .......................................... -- (458,952,405) -------------- --------------- Capital share transactions: (Note 2) Class Z ................................................................ (41,488,198) 70,935,652 Class A ................................................................ 30,925,009 (1,449,463) Class B ................................................................ (5,836,337) (7,916,883) Class C ................................................................ (2,453,444) (8,518,953) Class R ................................................................ 5,000 -- -------------- --------------- Total capital share transactions ............................................. (18,847,970) 53,050,353 -------------- --------------- Redemption fees .............................................................. -- 15,547 -------------- --------------- Net increase (decrease) in net assets ............................... 206,856,142 (1,953,015,626) Net assets: Beginning of period .......................................................... 4,334,543,547 6,287,559,173 -------------- --------------- End of period ................................................................ $4,541,399,689 $ 4,334,543,547 -------------- --------------- Undistributed net investment income (distributions in excess of net investment income) included in net assets: End of period ................................................................ $ 25,427,108 $ (1,346,885) ============== ===============
The accompanying notes are an integral part of these financial statements. 34 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual Quest Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers five classes of shares: Class Z, Class A, Class B, Class C, and Class R. Effective May 1, 2009, the Fund began offering a new class of shares, Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Effective May 1, 2009, the Mutual Qualified Fund was renamed the Mutual Quest Fund. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment Semiannual Report | 35 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. SECURITIES PURCHASED ON A DELAYED DELIVERY BASIS The Fund may purchase securities on a delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although 36 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. SECURITIES PURCHASED ON A DELAYED DELIVERY BASIS (CONTINUED) the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. D. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counter-party to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. The Fund purchases or writes option contracts in order to manage equity price risk. An option is a contract entitling the holder to purchase or sell a specific amount of shares or units of a particular security, currency or index at a specified price. Options purchased are recorded as an asset while options written are recorded as a liability. Upon exercise of an option, the acquisition cost or sales proceeds of the security is adjusted by any premium paid or received. Upon expiration of an option, any premium paid or received is recorded as a realized loss or gain. Upon closing an option other than through expiration or exercise, the difference between the premium and the cost to close the position is recorded as a realized gain or loss. See Note 11 regarding other derivative information. Semiannual Report | 37 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. F. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund incurs a loss if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit with broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the coun-terparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. G. SPECIAL PURPOSE ENTITIES At June 30, 2009, the Fund contributed an additional $11,392,484 as a subordinated note holder of certain special purpose entities ("SPEs"). Such contributions, while made at the discretion of the Fund, represent additional capital contributions to the SPE in support of its underlying investments and are subject first to the claims of the senior note holders of the SPE. These contributions are recorded as an addition to the Fund's cost basis in the SPE and are subject to the risk of loss in the event of continued unfavorable market conditions related to the SPE's underlying investments. H. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. 38 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I.INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. J. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Semiannual Report | 39 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) L.REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the Fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. M. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ---------------------------- ---------------------------- SHARES AMOUNT SHARES AMOUNT ----------- ------------- ----------- ------------- CLASS Z SHARES: Shares sold ....................... 7,479,704 $ 108,540,761 11,122,574 $ 209,614,477 Shares issued in reinvestment of distributions .................. -- -- 21,179,571 311,672,139 Shares redeemed ................... (10,419,479) (150,028,959) (24,315,473) (450,350,964) ----------- ------------- ----------- ------------- Net increase (decrease) ........... (2,939,775) $ (41,488,198) 7,986,672 $ 70,935,652 =========== ============= =========== ============= CLASS A SHARES: Shares sold ....................... 12,142,234 $ 175,494,128 18,274,974 $ 333,446,293 Shares issued in reinvestment of distributions .................. -- -- 5,851,226 85,559,773 Shares redeemed ................... (10,074,005) (144,569,119) (22,653,674) (420,455,529) ----------- ------------- ----------- ------------- Net increase (decrease) ........... 2,068,229 $ 30,925,009 1,472,526 $ (1,449,463) =========== ============= =========== ============= CLASS B SHARES: Shares sold ....................... 89,944 $ 1,266,921 186,946 $ 3,373,974 Shares issued in reinvestment of distributions .................. -- -- 267,986 3,835,934 Shares redeemed ................... (508,288) (7,103,258) (825,352) (15,126,791) ----------- ------------- ----------- ------------- Net increase (decrease) ........... (418,344) $ (5,836,337) (370,420) $ (7,916,883) =========== ============= =========== =============
40 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST (CONTINUED)
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009(a) DECEMBER 31, 2008 -------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------- CLASS C SHARES: Shares sold ....................... 2,534,564 $ 36,149,745 4,076,156 $ 73,178,814 Shares issued in reinvestment of distributions .................. -- -- 2,049,328 29,714,490 Shares redeemed ................... (2,737,663) (38,603,189) (6,127,082) (111,412,257) ---------- ------------ ---------- ------------- Net increase (decrease) ........... (203,099) $ (2,453,444) (1,598) $ (8,518,953) ========== ============ ========== ============= CLASS R SHARES: Shares sold ....................... 342 $ 5,000 ---------- ------------ Net increase (decrease) ........... 342 $ 5,000 ========== ============
(a) For the period May 1, 2009 (effective date) to June 30, 2009 for Class R. 3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Investment Management Limited (FTIML) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- ------------------------------------------------ 0.600% Up to and including $5 billion 0.570% Over $5 billion, up to and including $7 billion 0.550% Over $7 billion, up to and including $10 billion 0.540% In excess of $10 billion
Under a subadvisory agreement, FTIML, an affiliate of Franklin Mutual, provides subadvisory services to the Fund and receives from Franklin Mutual fees based on the average daily net assets of the Fund. Semiannual Report | 41 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- ------------------------------------------------ 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B, C, and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ....... 0.35% Class B ....... 1.00% Class C ....... 1.00% Class R ....... 0.50%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers ..................... $351,510 Contingent deferred sales charges retained ......... $ 22,443
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $2,012,414, of which $1,561,077 was retained by Investor Services. 42 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the Plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. During the period ended June 30, 2009, the Fund's projected benefit obligation and benefit payments under the Plan were as follows: (a) Projected benefit obligation at June 30, 2009 .............. $162,252 (b) Increase in projected benefit obligation ................... $ 7,418 Benefit payments made to retired trustees .................. $ 3,551
(a) The projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is included in trustees' fees and expenses in the Statement of Operations. 6. INCOME TAXES For tax purposes, realized capital losses and realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses and realized currency losses of $22,557,980 and $4,033,228, respectively. At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ..................................... $4,466,974,592 ============== Unrealized appreciation ................................. $ 669,703,230 Unrealized depreciation ................................. (457,098,810) -------------- Net unrealized appreciation (depreciation) .............. $ 212,604,420 ==============
Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through entity income, and bond discounts and premiums. Semiannual Report | 43 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 6. INCOME TAXES (CONTINUED) Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, pass-through entity income, and bond discounts and premiums. 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $990,423,899 and $333,407,314, respectively. Transactions in options written during the period ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED --------- ------------ Options outstanding at December 31, 2008 .. 13,858 $ 8,642,578 Options written ........................... 7,146,052 16,526,130 Options expired ........................... (15,166) (10,441,194) Options exercised ......................... -- -- Options closed ............................ -- -- --------- ------------ Options outstanding at June 30, 2009 ...... 7,144,744 $ 14,727,514 ========= ============
8. CREDIT RISK AND DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. If it becomes probable that income on debt securities, including those of distressed companies, will not be collected, the Fund discontinues accruing and recognizes a reserve for uncollectible interest. At June 30, 2009, the aggregate value of distressed company securities and securities for which interest has been discontinued was $19,576,245, representing 0.43% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these 44 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED) securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ---------------------------------------- ------------------ ----------- ----------- 402,522 AboveNet Inc. .......................... 10/02/01 - 8/08/08 $21,201,790 $32,596,232 510 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ............................. 4/17/06 - 9/08/06 -- 30,615 16,099 AboveNet Inc., wts., 9/08/10 ........... 10/02/01 - 9/07/07 1,681,196 925,692 7,519,799 Cerberus CG Investor I LLC ............. 7/26/07 - 6/17/08 7,494,044 1,428,762 6,600,000 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............................. 7/26/07 6,600,000 1,254,000 7,519,799 Cerberus CG Investor II LLC ............ 7/26/07 - 6/17/08 7,494,044 1,428,762 6,600,000 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............................. 7/26/07 6,600,000 1,254,000 3,759,899 Cerberus CG Investor III LLC ........... 7/26/07 - 6/17/08 3,747,022 714,381 3,300,000 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............................. 7/26/07 3,300,000 627,000 16,133,491 Cerberus FIM Investors Holdco LLC ...... 11/20/06 - 6/02/09 16,133,491 1,174,518 47,747,515 Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 .................... 11/21/06 47,747,515 3,473,679 1,008,199 (a) DecisionOne Corp. ...................... 3/12/99 - 7/18/00 700,978 1,663,529 1,324,103 (a) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 .................... 6/01/09 1,324,103 1,478,361 553,576 (a) DecisionOne Corp., wts., 6/08/17 ....... 7/09/07 -- -- 27,946 Elephant Capital Holdings Ltd .......... 8/29/03 - 3/10/08 3,250,275 -- 659,105 First Chicago Bancorp .................. 11/16/06 9,227,470 1,662,343 180,986 IACNA Investor LLC ..................... 7/24/08 - 8/08/08 185,348 1,810 2,814,856 Imagine Group Holdings Ltd. ............ 8/31/04 28,828,348 25,642,494 2,363,058 International Automotive Components Group Brazil LLC .................... 4/13/06 - 12/26/08 1,585,194 2,115,978 307,801 International Automotive Components Group Japan LLC ..................... 9/26/06 - 3/27/07 2,672,236 851,468 8,425,843 (b) International Automotive Components Group LLC ........................... 1/12/06 - 10/16/06 8,428,025 1,911,824 1,560,200 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ........ 3/30/07 1,583,603 707,914 5,182,488 International Automotive Components Group NA LLC, A ..................... 3/30/07 - 10/10/07 5,130,079 197,453
Semiannual Report | 45 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ---------------------------------------------------- ------------------ ----------- ------------ 4,285 Motor Coach Industries International Inc. ............................................ 4/17/09 $ 4,933,364 $ 5,572,642 30,746 Motor Coach Industries International Inc., pfd. ...................................... 4/17/09 30,746,000 30,746,000 129,974 NCB Warrant Holdings Ltd., A ....................... 12/16/05 - 3/10/08 1,368,433 -- 97,300 Olympus Re Holdings Ltd. ........................... 12/19/01 9,409,076 212,639 18,093,040 Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ................................. 1/22/08 - 2/25/08 25,175,604 17,361,233 2,869,673 Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ................. 2/29/08 7,179,593 4,999,203 92,938 PTV Inc., 10.00%, pfd., A .......................... 12/07/01 - 3/06/02 58,551 22,305 3,434,760 Symetra Financial .................................. 7/27/04 39,480,000 50,353,582 ------------ TOTAL RESTRICTED SECURITIES (4.19% of Net Assets) .. $190,408,419 ============
(a) The Fund also invests in unrestricted securities of the issuer, valued at $259,589 as of June 30, 2009. (b) The Fund also invests in unrestricted securities of the issuer, valued at $1,027,724 as of June 30, 2009. 10. UNFUNDED CAPITAL COMMITMENTS The Fund may enter into certain capital commitments and may be obligated to perform on such agreements at a future date. Unfunded capital commitments requiring recognition are monitored for impairment and any unrealized deprecation is included in the Statement of Assets and Liabilities and the Statement of Operations. At June 30, 2009, the Fund had aggregate unfunded capital commitments of $3,352,629, for which no depreciation has been recognized. 11. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS ASSET DERIVATIVES LIABILITY DERIVATIVES HEDGING INSTRUMENTS --------------------------------------- ---------------------------------------- UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ---------- -------------------------- ----------- Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $1,933,586 forward exchange contracts $77,222,779 Equity contracts ... Investments, at value 30,615 Options written, at value 20,777,623
46 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 11. OTHER DERIVATIVE INFORMATION (CONTINUED) For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- -------------------------------------- -------------- ------------- ------------- Foreign exchange contracts ....... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $50,883,665 $(91,929,783) 1,212,567,668 Equity contracts ... Net realized gain (loss) from written options / Net change in unrealized appreciation (depreciation) on investments 10,441,194 (4,743,628) 3,401,374
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(d) regarding derivative financial instruments. 12. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund for the period ended June 30, 2009, were as shown below.
NUMBER OF SHARES/WARRANTS/ NUMBER OF PRINCIPAL SHARES/WARRANTS/ REALIZED AMOUNT HELD PRINCIPAL AMOUNT VALUE AT CAPITAL AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT GAIN NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME (LOSS) - --------------------------------- ---------------- --------- ---------- ---------------- ----------- ---------- --------- NON-CONTROLLED AFFILIATES DecisionOne Corp. ............... 1,008,199 -- -- 1,008,199 $ 1,663,529 $ -- $ -- DecisionOne Corp., 12.00%, 4/15/10 ...................... 1,297,728 26,375 1,324,103 -- -- 78,262 (343,994) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 ............. -- 1,324,103 -- 1,324,103 1,478,361 -- -- DecisionOne Corp., Term Loan B, 15.00%, 8/29/13 ........... 232,502 -- -- 232,502 259,589 7,004 -- DecisionOne Corp., wts., 6/08/17 ...................... 553,576 -- -- 553,576 -- -- -- Elephant Capital Holdings Ltd. .. 27,946 -- -- 27,946 -- -- -- First Chicago Bancorp ........... 659,105 -- -- 659,105 1,662,343 -- -- Imagine Group Holdings Ltd. ..... 2,814,856 -- -- 2,814,856 25,642,494 -- -- Imperial Capital Bancorp Inc. ... 445,796 -- -- 445,796 160,487 -- -- Motor Coach Industries International Inc. ........... -- 4,285 -- 4,285 5,572,642 -- -- Motor Coach Industries International Inc., pfd. ......................... -- 30,746 -- 30,746 30,746,000 -- -- White River Capital Inc. ........ 549,751 -- -- 549,751 5,126,428 -- -- ----------- ---------- --------- TOTAL AFFILIATED SECURITIES (1.59% of Net Assets) ..... $72,311,873 $ 85,266 $(343,994) =========== ========== =========
Semiannual Report | 47 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of boards of bondholders' steering committees, official creditors' committees, or directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Franklin Mutual serves as investment manager to certain special purpose entities that issue securities held by the Fund. Franklin Mutual is not compensated for such services and does not invest in or exercise control over such entities. As investment manager, Franklin Mutual is primarily responsible for recommending investments in unaffiliated issuers to be held by the special purpose entities. Securities issued by these special purpose entities are restricted under the Securities Act of 1933 and are deemed to be illiquid. 14. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $13,435 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statements of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 48 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 15. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL -------------- ------------ ------------ -------------- ASSETS: Investments in Securities: Equity Investments:(a) Airlines ................ $ 5,564,157 $ 17,786 $ -- $ 5,581,943 Auto Components ......... -- -- 5,090,707 5,090,707 Chemicals ............... 6,820,574 -- 3,022,299 9,842,873 Commercial Banks ........ 70,798,293 -- 1,662,343 72,460,636 Commercial Services & Supplies ............. 7,861,229 -- --(b) 7,861,229 Computers & Peripherals .......... 55,087,574 -- 1,663,529 56,751,103 Consumer Finance ........ 5,126,428 -- 4,746,423 9,872,851 Diversified Financial Services ............. 28,370,356 -- --(b) 28,370,356 Diversified Telecommunication Services ............. 64,943,573 947,997 --(b) 65,891,570 Insurance ............... 229,051,055 -- 76,208,715 305,259,770 Machinery ............... 93,043,431 -- 36,318,642 129,362,073 Media ................... 18,510,162 1,887,271 --(b) 20,397,433 Multi-Utilities ......... 18,740,259 -- --(b) 18,740,259 Real Estate Management & Development .......... 46,670,118 -- 23,893,158 70,563,276 All other Equity Investments(c) ....... 2,257,171,242 -- -- 2,257,171,242 Corporate Bonds & Notes .... -- 113,725,893 32,853,570 146,579,463 Corporate Bonds & Notes in Reorganization .......... -- 12,259,452 200 12,259,652 Short Term Investments ..... 1,445,665,316 11,857,260 -- 1,457,522,576 -------------- ------------ ------------ -------------- Total Investments in Securities .............. $4,353,423,767 $140,695,659 $185,459,586 $4,679,579,012 ============== ============ ============ ============== Forward Exchange Contracts .... $ -- $ 1,933,586 $ -- $ 1,933,586
Semiannual Report | 49 Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 15. FAIR VALUE MEASUREMENTS (CONTINUED)
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL ------------ ----------- ------- ------------ LIABILITIES: Options Written ............. $ 16,606,865 $ 4,170,758 $-- $ 20,777,623 Securities Sold Short ....... 157,419,375 -- -- 157,419,375 Forward Exchange Contracts .. -- 77,222,779 -- 77,222,779
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN UNREALIZED APPRECIATION NET CHANGE (DEPRECIATION) IN ATTRIBUTABLE NET UNREALIZED NET TRANSFER TO ASSETS BEGINNING REALIZED APPRECIATION PURCHASES IN (OUT) OF ENDING STILL HELD BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) LEVEL 3 BALANCE AT PERIOD END ------------ ------------ -------------- ----------- ------------ ------------ -------------- ASSETS Investment in Securities: Equity Investments:(a) Auto Components .... $ 4,503,678 $ -- $ 594,718 $ (7,689) $ -- $ 5,090,707 $ 594,718 Chemicals .......... 3,022,299 -- -- -- -- 3,022,299 -- Commercial Banks ... 4,998,809 -- (3,336,466) -- -- 1,662,343 (3,336,466) Commercial Services & Supplies ...... -- -- -- -- -- --(b) -- Computers & Peripherals ..... -- -- 1,663,528 -- -- 1,663,528 1,663,528 Consumer Finance ... 7,131,508 -- (2,535,190) 150,105 -- 4,746,423 (2,535,190) Diversified Financial Services ........ -- -- -- -- -- --(b) -- Diversified Telecommunication Services ........ 20,191,644 -- 12,050,247 -- (32,241,891) --(b) -- Food Products ...... 9,578 -- (1,861) -- (7,717) -- -- Health Care Providers & Services ........ 18,010,662 -- 857,650 -- (18,868,312) -- -- Insurance .......... 68,930,052 -- 7,278,663 -- -- 76,208,715 7,278,663 Machinery .......... -- -- 639,279 35,679,364 -- 36,318,643 639,279 Media .............. -- -- -- -- -- --(b) -- Multi-Utilities .... -- -- -- -- -- --(b) -- Real Estate Management & Development ... 31,986,351 -- (8,093,193) -- -- 23,893,158 (8,093,193) Corporate Bonds & Notes .............. 37,812,784 (343,994) (1,446,737) (3,168,483) -- 32,853,570 (1,790,731) Corporate Bonds & Notes in Reorganization .. 710,485 (21,084,385) 25,307,464 (4,933,364) -- 200 -- ------------ ------------ ------------ ----------- ------------ ------------ ------------ Total ................. $197,307,850 $(21,428,379 $ 32,978,102 $27,719,933 $(51,117,920) $ 185,459,58 $ (5,579,392) ============ ============ ============ =========== ============ ============ ============
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. 50 | Semiannual Report Mutual Quest Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 17, 2009 and determined that no events have occurred that require disclosure. ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound SELECTED PORTFOLIO ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - The Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 51 Mutual Quest Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. 52 | Semiannual Report Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counterparty credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and its long-term relationship with the Fund as reasons that shareholders choose to invest, and Semiannual Report | 53 Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) remain invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative 54 | Semiannual Report Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional multi-cap value funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the best performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the best performing quintiles. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quintile and exceeded 6%, as shown in the Lipper Section 15(c) Report. The Board was satisfied with such comparative performance. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's best performing quintile of peer funds for the three-, five- and 10-year periods ended December 31, 2008. The trustees concluded that, while the Fund's losses over the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years. The trustees noted that the Fund's overall expense ratio has declined over such period. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Semiannual Report | 55 Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the middle quintile of its Lipper expense group and its total expenses were in the second least expensive quintile of such group. The Board was satisfied with such comparative expenses. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. 56 | Semiannual Report Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative relationship of investment management and underwriting expenses; shareholder servicing profitability (losses); economies of scale; and the relative contribution of the Fund to the profitability of the investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004. The trustees assessed the savings to shareholders resulting from such breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor Semiannual Report | 57 Mutual Quest Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) the appropriateness of the breakpoints. The trustees also considered the effects an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. 58 | Semiannual Report This page intentionally left blank. This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL QUEST FUND (FORMERLY, MUTUAL QUALIFIED FUND) INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B & C) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 475 S2009 08/09 JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" (GRAPHIC) VALUE MUTUAL BEACON FUND (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES FRANKLIN TEMPLETON INVESTMENTS GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services.
MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ....................................... 1 SEMIANNUAL REPORT Mutual Beacon Fund ....................................... 4 Performance Summary ...................................... 11 Your Fund's Expenses ..................................... 14 Financial Highlights and Statement of Investments ........ 16 Financial Statements ..................................... 30 Notes to Financial Statements ............................ 34 Shareholder Information .................................. 52
Shareholder Letter Dear Mutual Beacon Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In the U.S. and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. During the period, the U.S. unemployment rate rose to its highest level in 25 years, housing prices continued their precipitous declines and 30-year U.S. Treasury yields plummeted to a 30-year low of around 2.5%, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of financial services companies on the scale of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of major bank nationalization was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The low in early March for the Standard & Poor's 500 Index -- down 26% from 2008 year-end and 57% from its peak in October 2007 -- was followed by a 42% rebound to its recent, second-quarter high on June 11.(1) The 57% drop was the third worst since 1900.(1) At the same time, yields on 30-year Treasuries shot up to 4.8% in June, (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Standard & Poor's 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The index is one of the most widely used benchmarks of U.S. equity performance. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 resulting in their worst six-month performance in over 16 years. European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed that the recovery in Europe would be slower than in the U.S. Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, the results of the government "stress test" of major financial institutions were generally positive, enabling many of those institutions to raise capital in the public markets and avoid a worst-case scenario of government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Additionally, the bankruptcies of General Motors and Chrysler, although particularly painful for dealers, suppliers and those directly dependent on the auto industry, were absorbed without triggering further systemic risk. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual Beacon Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities, attractive merger arbitrage situations, and distressed debt opportunities. Consistent with the expectations outlined in our 2008 year-end letter, we added to companies in economically defensive industries, with strong market positions, high barriers to entry, and reasonably predictable earnings and cash flows, including companies in the consumer staples sector and the health care sector. We also anticipated purchases in some economically sensitive industries, and likewise increased our investments in some energy companies where we believe we found good value. Late in 2008 and early in 2009, we began to find opportunities in senior secured corporate loans trading at levels we perceived reflected mispriced risk. These are exactly the types of opportunities that we patiently wait for and that we had not seen since the last big credit default cycle of 2001-2003, which included the frauds at Enron, Tyco and WorldCom. On the bankruptcy front 2 | Not part of the semiannual report recently, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we like, although we expect more of these as "covenant lite," highly leveraged balance sheets eventually reach a tipping point. On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. However, a few large health care deals did emerge as those acquirers took advantage of their relatively stable cash flows and strong balance sheets to pursue a needed rationalization of the industry. The good news here is that we believe the potential returns for these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual Beacon Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Beacon Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 35% of its assets in foreign securities. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. We are pleased to bring you Mutual Beacon Fund's semiannual report for the period ended June 30, 2009. PERFORMANCE OVERVIEW Mutual Beacon Fund - Class Z delivered a +6.84% cumulative total return for the six months ended June 30, 2009. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which had a +3.16% total return for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the six-month period ended June 30, 2009, the U.S. economy and stock markets seemed to stabilize after signs appeared that the recession's severity had eased. Strains on the banking system and credit markets that surfaced in 2008 improved in 2009's first half with the help of federal aid and tighter regulations. Despite rising unemployment, near period-end home sales edged higher, the decline in manufacturing activity slowed and consumer confidence started to pick up. Economic activity as measured by gross domestic product (GDP) fell at annualized rates of 6.4% and an estimated 1.0% in the first and second quarters of 2009. (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. 4 | Semiannual Report Although the price of oil rose from $44 per barrel at the beginning of the period to $70 by period-end on speculation that the downturn was abating, it was still off more than 50% from its July 2008 record high.(2) June's inflation rate, as measured by the Consumer Price Index, was an annualized -1.4%, representing the steepest yearly decline in the cost of living in nearly six decades.(3) Core inflation, which excludes food and energy costs, rose at a 1.7% annualized rate, which was within the Federal Reserve Board's (Fed's) informal target range of 1.5%-2.0%.(3) A deepening recession and decelerating inflation prompted Washington policy-makers to keep interest rates low and enact stimulus plans -- including income tax cuts, aid to ailing state governments and funding for transportation infrastructure, school construction and high-tech projects. During the period under review, the Fed kept the federal funds target rate in a range of 0% to 0.25% and said the "pace of economic contraction is slowing" but the financial system had not yet returned to normal. Most U.S. stocks suffered major losses through early March as investors worried about an uncertain future. Stocks then recovered somewhat from 12-year lows as investors perceived many bargains among the bear market fallout and data indicated the economy's pace of contraction was moderating. By June, however, fresh investor concerns about the economy and stock valuations reemerged and dampened the rally's momentum. For the six months under review, the blue chip stocks of the Dow Jones Industrial Average had a total return of -2.01%, while the broader S&P 500 posted a +3.16% total return and the technology-heavy NASDAQ Composite Index returned +16.99%.(4) Global equities followed the same trend. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk appetite, rotating capital back into cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 U.S. 64.4% U.K. 7.2% Switzerland 3.3% Germany 3.3% Norway 2.7% Denmark 1.8% France 1.6% Spain 1.4% Netherlands 1.4% Japan 1.0% Other 1.2% Short-Term Investments & Other Net Assets 10.7%
(2.) Source: New York Mercantile Exchange. (3.) Source: Bureau of Labor Statistics. (4.) Source: (C) 2009 Morningstar. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. Semiannual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Insurance 8.7% Tobacco 8.5% Media 7.7% Pharmaceuticals 6.8% Food Products 5.2% Diversified Telecommunication Services 4.8% Beverages 3.9% Paper & Forest Products 3.5% Software 3.5% Energy Equipment & Services 2.7%
assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. In the reporting period's final weeks, global equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(5) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(6) INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. (5.) Source: European Communities Eurostat. (6.) Source: People's Bank of China. 6 | Semiannual Report We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION During the first half of 2009, Mutual Beacon's best performing investments included Marine Harvest, a Norway-based farmed salmon producer; Temple-Inland, a manufacturer of corrugated packaging and building products; and software provider Microsoft. Investor concerns about Chilean salmon production sent Marine Harvest's share price plunging in 2008. In our view, investors had forgotten that lower salmon supply would normally translate into higher prices. As salmon prices increased by more than 40% during the first half of 2009, Marine Harvest's cash flow increased and it regained investor interest. Besides operational gearing, financial gearing also positively affected Marine Harvest's share price. Largely as a result of these conditions, Marine Harvest's share price roughly quadrupled during the six-month period. Temple-Inland's performance was driven by better-than-expected first quarter 2009 operating results and evidence of stabilization in the market for, and pricing of, containerboard. In our view, the company's positive earnings surprise can be attributed to management's focus on free cash flow, improving asset utilization, accurately matching production supply with customer TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Microsoft Corp. 3.5% SOFTWARE, U.S. Wyeth 3.4% PHARMACEUTICALS, U.S. Comcast Corp., A 2.8% MEDIA, U.S. News Corp., A 2.4% MEDIA, U.S. Berkshire Hathaway Inc., A & B 2.3% INSURANCE, U.S. Imperial Tobacco Group PLC 2.3% TOBACCO, U.K. CVS Caremark Corp. 2.2% FOOD & STAPLES RETAILING, U.S. White Mountains Insurance Group Ltd. 2.2% INSURANCE, U.S. Schering-Plough Corp. 2.1% PHARMACEUTICALS, U.S. Weyerhaeuser Co. 1.9% PAPER & FOREST PRODUCTS, U.S.
Semiannual Report | 7 demand, and stronger operating performance in both its mainstay container-board business and its cyclically depressed building products unit. In addition, evidence of a slowly recovering containerboard market emerged in Temple-Inland's monthly reports, revealing low inventory levels and modest improvements in sequential demand, both of which helped mitigate overall price and volume deterioration. Microsoft manufactures, licenses and supports a wide range of proprietary software products and services, and is the world's largest software company. Companywide cost controls implemented in late 2008 gained traction and began to benefit operating results in 2009. Microsoft also announced several new products, including a rebranded search engine, Bing, and the next version of the Windows operating system. The combination of cost discipline and new revenue opportunities appeared to revitalize the company and Microsoft's image with investors. Although the Fund outperformed the benchmark S&P 500 during the first half of 2009, it had some disappointments. Three investments that declined in value were in Exterran Holdings, which rents and repairs compressors and performs natural gas compression services for oil and gas companies; Eastman Kodak, which makes a wide range of products for film and digital imaging; and Comcast, a cable services provider. Exterran's share price fell as the company experienced downward margin pressure in all of its business segments. In particular, compressor utilization and fabrication backlog in North America, where the company does about 90% of its business, decreased in response to weaker demand amid substantially lower natural gas prices. Furthermore, Exterran realized an impairment charge on its Venezuelan assets due to the Venezuelan government's expropriation of various oil service assets, including those owned by Exterran. Our investment in Eastman Kodak declined significantly because the company reported a bigger first quarter 2009 loss than analysts expected, due largely to declining revenues. The significant deceleration was a result of a slowdown in consumer spending on film products and digital cameras, as well as widespread capital expenditure deferrals among the company's corporate customers. Subsequently, the company also suspended its dividend. Comcast shares fell after the company reported a decline in subscriber growth across all products -- video, data and telephony -- in its 2008 fourth quarter results. In addition, given the improvement in corporate debt markets during the second quarter and Comcast's relatively underleveraged balance sheet, investors began to anticipate a more significant increase in the dividend and/or an increase in share repurchase activity. The fact that the company undertook neither appeared to create uncertainty and sparked speculation about potential merger and acquisition activity. 8 | Semiannual Report Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual Beacon Fund. We look forward to serving your future investment needs. (PHOTO OF CHRISTIAN CORREA) /s/ Christian Correa Christian Correa, CFA Portfolio Manager (PHOTO OF MANDANA HORMOZI) /s/ Mandana Hormozi Mandana Hormozi Assistant Portfolio Manager Mutual Beacon Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Semiannual Report | 9 CHRISTIAN CORREA has been portfolio manager for Mutual Beacon Fund since 2007. He has been an analyst for Franklin Mutual Advisers since 2003, when he joined Franklin Templeton Investments. Previously, he covered U.S. risk arbitrage and special situations at Lehman Brothers Holdings Inc. MANDANA HORMOZI has been assistant portfolio manager for Mutual Beacon Fund since May 2009. Before that, she was assistant portfolio manager for Mutual Discovery Fund since 2007. She has been an analyst for Franklin Mutual Advisers since 2003, when she joined Franklin Templeton Investments. Previously, she was a senior vice president in the equity research department at Lazard Freres. Also, she was an economic research analyst at Mitsubishi Bank. 10 | Semiannual Report Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: BEGRX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.62 $9.69 $9.07
CLASS A (SYMBOL: TEBIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.59 $9.58 $8.99
CLASS B (SYMBOL: TEBBX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.54 $9.22 $8.68
CLASS C (SYMBOL: TEMEX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.55 $9.39 $8.84
Semiannual Report | 11 Performance Summary (CONTINUED) PERFORMANCE(1) CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------ ------- Cumulative Total Return(2) +6.84% -25.28% -3.69% +37.63% Average Annual Total Return(3) +6.84% -25.28% -0.75% +3.25% Value of $10,000 Investment(4) $10,684 $ 7,472 $9,631 $13,763 Total Annual Operating Expenses(5) 0.84%
CLASS A 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------ ------- Cumulative Total Return(2) +6.56% -25.52% -5.27% +33.08% Average Annual Total Return(3) +0.42% -29.79% -2.25% +2.29% Value of $10,000 Investment(4) $10,042 $ 7,021 $8,926 $12,543 Total Annual Operating Expenses(5) 1.13%
CLASS B 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------ ------- Cumulative Total Return(2) +6.22% -26.01% -8.38% +26.31% Average Annual Total Return(3) +2.22% -28.87% -2.01% +2.36% Value of $10,000 Investment(4) $10,222 $ 7,113 $9,034 $12,631 Total Annual Operating Expenses(5) 1.84%
CLASS C 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------ ------- Cumulative Total Return(2) +6.22% -26.01% -8.42% +24.53% Average Annual Total Return(3) +5.22% -26.72% -1.74% +2.22% Value of $10,000 Investment(4) $10,522 $ 7,328 $9,158 $12,453 Total Annual Operating Expenses(5) 1.84%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. 12 | Semiannual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. (1). Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2). Cumulative total return represents the change in value of an investment over the periods indicated. (3). Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4). These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5). Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. Semiannual Report | 13 Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Semiannual Report Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 ----------------- -------------- ---------------------- CLASS Z Actual $1,000 $1,068.40 $ 9.08 Hypothetical (5% return before expenses) $1,000 $1,016.02 $ 8.85 CLASS A Actual $1,000 $1,065.60 $10.65 Hypothetical (5% return before expenses) $1,000 $1,014.48 $10.39 CLASS B Actual $1,000 $1,062.20 $14.16 Hypothetical (5% return before expenses) $1,000 $1,011.06 $13.81 CLASS C Actual $1,000 $1,062.20 $14.16 Hypothetical (5% return before expenses) $1,000 $1,011.06 $13.81
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.77%; A: 2.08%; B: 2.77%; and C: 2.77%), multiplied by the average account value over the period, multiplied by 181/365 to reflect the one-half year period. Semiannual Report | 15 Mutual Beacon Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .......................... $ 9.07 $ 15.73 $ 16.71 $ 15.52 $ 15.94 $ 14.40 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ........ 0.03(c) 0.25 0.51 0.26 0.31 0.30 Net realized and unrealized gains (losses) ............... 0.59 (6.46) -- 2.91 1.16 1.76 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ... 0.62 (6.21) 0.51 3.17 1.47 2.06 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income ........... -- (0.03) (0.57) (0.28) (0.30) (0.37) Net realized gains .............. -- (0.42) (0.92) (1.70) (1.59) (0.15) ---------- ---------- ---------- ---------- ---------- ---------- Total distributions ................ -- (0.45) (1.49) (1.98) (1.89) (0.52) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) ................. -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ..... $ 9.69 $ 9.07 $ 15.73 $ 16.71 $ 15.52 $ 15.94 ========== ========== ========== ========== ========== ========== Total return(f) .................... 6.84% (40.37)% 3.03% 20.98% 9.25% 14.52% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h,i) ...................... 1.77% 0.84% 0.82% 0.85% 0.89% 0.83% Expenses - excluding dividend expense on securities sold short and stock loan fees(h) .... 0.89% 0.84% 0.81% 0.82% 0.84% 0.82% Net investment income .............. 0.66%(c) 1.90% 2.89% 1.59% 1.91% 1.99% SUPPLEMENTAL DATA Net assets, end of period (000's) .. $2,020,391 $2,002,361 $3,883,935 $3,925,029 $3,433,665 $3,359,389 Portfolio turnover rate ............ 29.31% 56.87% 49.84% 40.72% 35.36% 29.17%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.89%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short and stock loan fees which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 8.99 $ 15.62 $ 16.61 $ 15.44 $ 15.87 $ 14.34 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ............ 0.02(c) 0.20 0.45 0.21 0.26 0.25 Net realized and unrealized gains (losses) ......................... 0.57 (6.38) -- 2.90 1.15 1.75 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ....... 0.59 (6.18) 0.45 3.11 1.41 2.00 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income ............... -- (0.03) (0.52) (0.24) (0.25) (0.32) Net realized gains .................. -- (0.42) (0.92) (1.70) (1.59) (0.15) ---------- ---------- ---------- ---------- ---------- ---------- Total distributions .................... -- (0.45) (1.44) (1.94) (1.84) (0.47) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ......... $ 9.58 $ 8.99 $ 15.62 $ 16.61 $ 15.44 $ 15.87 ========== ========== ========== ========== ========== ========== Total return(f) ........................ 6.56% (40.48)% 2.67% 20.65% 8.89% 14.13% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 2.08% 1.13% 1.14% 1.15% 1.22% 1.18% Expenses - excluding dividend expense on securities sold short and stock loan feesh .......................... 1.20% 1.13% 1.13% 1.12% 1.17% 1.17% Net investment income .................. 0.35%(c) 1.61% 2.57% 1.29% 1.58% 1.64% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $1,592,988 $1,659,062 $2,654,731 $2,176,658 $1,633,022 $1,462,133 Portfolio turnover rate ................ 29.31% 56.87% 49.84% 40.72% 35.36% 29.17%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.58%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short and stock loan fees which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 8.68 $ 15.19 $ 16.17 $ 15.09 $ 15.54 $ 14.06 ------- ------- -------- -------- -------- -------- Income from investment operations(a): Net investment income (loss)(b) ..... (0.01)(c) 0.12 0.32 0.10 0.14 0.15 Net realized and unrealized gains (losses) ......................... 0.55 (6.19) 0.01 2.80 1.14 1.71 ------- ------- -------- -------- -------- -------- Total from investment operations ....... 0.54 (6.07) 0.33 2.90 1.28 1.86 ------- ------- -------- -------- -------- -------- Less distributions from: Net investment income ............... -- (0.02) (0.39) (0.12) (0.14) (0.23) Net realized gains .................. -- (0.42) (0.92) (1.70) (1.59) (0.15) ------- ------- -------- -------- -------- -------- Total distributions .................... -- (0.44) (1.31) (1.82) (1.73) (0.38) ------- ------- -------- -------- -------- -------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) ------- ------- -------- -------- -------- -------- Net asset value, end of period ......... $ 9.22 $ 8.68 $ 15.19 $ 16.17 $ 15.09 $ 15.54 ======= ======= ======== ======== ======== ======== Total return(f) ........................ 6.22% (40.88)% 1.95% 19.86% 8.17% 13.32% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 2.77% 1.84% 1.81% 1.85% 1.89% 1.83% Expenses - excluding dividend expense on securities sold short and stock loan feesh .......................... 1.89% 1.84% 1.80% 1.82% 1.84% 1.82% Net investment income .................. (0.34)%(c) 0.90% 1.90% 0.59% 0.91% 0.99% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $61,385 $73,168 $171,628 $199,461 $186,169 $186,840 Portfolio turnover rate ................ 29.31% 56.87% 49.84% 40.72% 35.36% 29.17%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.89%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short and stock loan fees which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 8.84 $ 15.47 $ 16.46 $ 15.33 $ 15.77 $ 14.26 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income (loss)(b) ..... (0.01)(c) 0.12 0.33 0.10 0.15 0.14 Net realized and unrealized gains (losses) ......................... 0.56 (6.31) -- 2.85 1.14 1.74 -------- -------- -------- -------- -------- -------- Total from investment operations ....... 0.55 (6.19) 0.33 2.95 1.29 1.88 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ............... -- (0.02) (0.40) (0.12) (0.14) (0.23) Net realized gains .................. -- (0.42) (0.92) (1.70) (1.59) (0.14) -------- -------- -------- -------- -------- -------- Total distributions .................... -- (0.44) (1.32) (1.82) (1.73) (0.37) -------- -------- -------- -------- -------- -------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- -------- Net asset value, end of period ......... $ 9.39 $ 8.84 $ 15.47 $ 16.46 $ 15.33 $ 15.77 ======== ======== ======== ======== ======== ======== Total return(f) ........................ 6.22% (40.92)% 1.99% 19.84% 8.12% 13.39% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 2.77% 1.84% 1.81% 1.85% 1.89% 1.83% Expenses - excluding dividend expense on securities sold short and stock loan fees(h)............................... 1.89% 1.84% 1.80% 1.82% 1.84% 1.82% Net investment income (loss) ........... (0.34)%(c) 0.90% 1.90% 0.59% 0.91% 0.99% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $392,097 $417,549 $875,060 $825,234 $697,400 $658,813 Portfolio turnover rate ................ 29.31% 56.87% 49.84% 40.72% 35.36% 29.17%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.89%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short and stock loan fees which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 19 Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/WARRANTS/ COUNTRY CONTRACTS/RIGHTS VALUE -------------- ---------------- -------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 83.0% AEROSPACE & DEFENSE 0.9% United Technologies Corp. ................................ United States 696,830 $ 36,207,287 -------------- AIRLINES 0.0%(a) (b) ACE Aviation Holdings Inc., A ............................ Canada 328,868 1,498,775 (b, c) Northwest Airlines Corp., Contingent Distribution ........ United States 35,952,000 22,650 -------------- 1,521,425 -------------- AUTO COMPONENTS 0.4% (b, c, d) Collins & Aikman Products Co., Contingent Distribution ... United States 1,506,491 15,065 (b, c, d) Dana Holding Corp., Contingent Distribution .............. United States 16,890,000 -- (b, e) IACNA Investor LLC ....................................... United States 225,943 2,259 (b, e, f) International Automotive Components Group Brazil LLC ..... Brazil 2,846,329 2,548,719 (b, e, f) International Automotive Components Group Japan LLC ...... Japan 378,194 1,046,196 (b, e, f) International Automotive Components Group LLC ............ Luxembourg 10,149,082 2,302,827 (b, e, f) International Automotive Components Group NA LLC, A ...... United States 6,469,827 246,500 -------------- 6,161,566 -------------- AUTOMOBILES 0.1% Daimler AG ............................................... Germany 444,830 16,047,186 -------------- BEVERAGES 3.9% Brown-Forman Corp., A .................................... United States 308,260 14,213,869 Brown-Forman Corp., B .................................... United States 530,337 22,793,884 Carlsberg AS, A .......................................... Denmark 74,900 4,902,109 Carlsberg AS, B .......................................... Denmark 577,744 37,050,915 (b) Dr. Pepper Snapple Group Inc. ............................ United States 1,544,830 32,734,948 Lion Nathan Ltd. ......................................... Australia 767,806 7,153,450 Pepsi Bottling Group Inc. ................................ United States 935,000 31,640,400 PepsiAmericas Inc. ....................................... United States 283,800 7,608,678 -------------- 158,098,253 -------------- CHEMICALS 0.5% (b, c, d) Dow Corning Corp., Contingent Distribution ............... United States 23,723,548 3,149,637 Koninklijke DSM NV ....................................... Netherlands 510,136 15,977,490 -------------- 19,127,127 -------------- COMMERCIAL BANKS 1.1% Barclays PLC ............................................. United Kingdom 2,918,310 13,588,646 BNP Paribas SA ........................................... France 533 34,576 (b, e, g) FE Capital Holdings Ltd. ................................. Japan 35,242 -- (b, e, g) First Chicago Bancorp .................................... United States 1,157,143 2,918,455 (b) Intesa Sanpaolo SpA ...................................... Italy 7,552,024 24,309,717 Intesa Sanpaolo SpA, di Risp ............................. Italy 1,633,348 4,022,880 (b, e) NCB Warrant Holdings Ltd., A ............................. Japan 163,895 -- -------------- 44,874,274 -------------- COMMERCIAL SERVICES & SUPPLIES 0.0%(a) (b) Comdisco Holding Co. Inc. ................................ United States 1,223 8,928 (b, c) Comdisco Holding Co. Inc., Contingent Distribution ....... United States 49,575,000 -- -------------- 8,928 --------------
20 | Semiannual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS/RIGHTS VALUE -------------- ---------------- -------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMPUTERS & PERIPHERALS 2.1% (b, e, g) DecisionOne Corp. ........................................ United States 1,142,353 $ 1,884,882 (b, e, g) DecisionOne Corp., wts., 6/08/17 ......................... United States 627,237 -- (b) Dell Inc. ................................................ United States 4,243,550 58,263,942 (b) Sun Microsystems Inc. .................................... United States 2,695,710 24,854,446 -------------- 85,003,270 -------------- CONSUMER FINANCE 1.2% (b, e, f, g) CB FIM Coinvestors LLC ................................... United States 15,831,950 36,147,508 (b,e) Cerberus CG Investor I LLC ............................... United States 20,610,629 3,916,020 (b,e) Cerberus CG Investor II LLC .............................. United States 20,610,629 3,916,020 (b,e) Cerberus CG Investor III LLC ............................. United States 10,305,315 1,958,010 (b,e) Cerberus FIM Investors Holdco LLC ........................ United States 19,805,560 1,441,845 -------------- 47,379,403 -------------- CONTAINERS & PACKAGING 1.0% Temple-Inland Inc. ....................................... United States 3,049,637 40,011,237 -------------- DIVERSIFIED CONSUMER SERVICES 0.4% Hillenbrand Inc. ......................................... United States 889,128 14,795,090 -------------- DIVERSIFIED FINANCIAL SERVICES 0.5% Deutsche Boerse AG ....................................... Germany 238,890 18,522,511 (b, d) Fortis, rts., 7/01/14 .................................... Belgium 2,978,030 -- (b, c) Marconi Corp., Contingent Distribution ................... United Kingdom 42,651,300 -- -------------- 18,522,511 -------------- DIVERSIFIED TELECOMMUNICATION SERVICES 4.8% (b, e) AboveNet Inc. ............................................ United States 484,720 39,252,626 (b, e) AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ............................... United States 613 36,798 (b, e) AboveNet Inc., wts., 9/08/10 ............................. United States 19,829 1,140,168 (b, c, d) Global Crossing Holdings Ltd., Contingent Distribution ... United States 60,632,757 -- Koninklijke KPN NV ....................................... Netherlands 2,903,470 39,905,519 Qwest Communications International Inc. .................. United States 13,716,090 56,921,773 Telefonica SA ............................................ Spain 2,524,533 57,079,472 -------------- 194,336,356 -------------- ELECTRIC UTILITIES 2.3% E.ON AG .................................................. Germany 1,698,600 60,109,378 Exelon Corp. ............................................. United States 675,843 34,609,920 -------------- 94,719,298 -------------- ENERGY EQUIPMENT & SERVICES 2.7% (b) Exterran Holding Inc. .................................... United States 2,848,874 45,695,939 (b) Transocean Ltd. .......................................... United States 882,985 65,596,956 -------------- 111,292,895 -------------- FOOD & STAPLES RETAILING 2.6% CVS Caremark Corp. ....................................... United States 2,868,194 91,409,343 SUPERVALU Inc. ........................................... United States 1,238,610 16,039,999 -------------- 107,449,342 --------------
Semiannual Report | 21 Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS/RIGHTS VALUE -------------- ---------------- -------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) FOOD PRODUCTS 5.2% Cadbury PLC .............................................. United Kingdom 2,878,407 $ 24,532,413 Danone ................................................... France 987,846 48,743,750 (g) Farmer Brothers Co. ...................................... United States 1,033,896 23,655,541 General Mills Inc. ....................................... United States 22,300 1,249,246 (b, h) Marine Harvest ........................................... Norway 72,384,735 48,609,811 Nestle SA ................................................ Switzerland 1,752,350 65,973,100 -------------- 212,763,861 -------------- HEALTH CARE PROVIDERS & SERVICES 2.0% (b) Community Health Systems Inc. ............................ United States 1,692,360 42,732,090 (b) Kindred Healthcare Inc. .................................. United States 826,139 10,219,340 (b) Tenet Healthcare Corp. ................................... United States 9,752,777 27,502,831 -------------- 80,454,261 -------------- HOTELS, RESTAURANTS & LEISURE 0.0%(a) (b) Trump Entertainment Resorts Inc. ......................... United States 408,933 69,519 -------------- INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 1.7% Constellation Energy Group ............................... United States 2,216,306 58,909,413 (b) NRG Energy Inc. .......................................... United States 411,294 10,677,192 -------------- 69,586,605 -------------- INDUSTRIAL CONGLOMERATES 2.4% (f) Orkla ASA ................................................ Norway 8,348,283 60,604,831 Siemens AG ............................................... Germany 562,130 38,815,077 -------------- 99,419,908 -------------- INSURANCE 8.7% ACE Ltd. ................................................. United States 869,890 38,475,235 (b) Alleghany Corp. .......................................... United States 176,463 47,821,473 (b) Berkshire Hathaway Inc., A ............................... United States 741 66,690,000 (b) Berkshire Hathaway Inc., B ............................... United States 9,555 27,668,700 (b, e) Olympus Re Holdings Ltd. ................................. United States 106,700 233,182 (b, e) Symetra Financial ........................................ United States 4,450,920 65,250,487 White Mountains Insurance Group Ltd. ..................... United States 383,121 87,700,228 Zurich Financial Services AG ............................. Switzerland 114,650 20,189,539 -------------- 354,028,844 -------------- IT SERVICES 1.7% (b) Alliance Data Systems Corp. .............................. United States 1,115,230 45,936,324 (b) DST Systems Inc. ......................................... United States 644,049 23,797,610 -------------- 69,733,934 -------------- LEISURE EQUIPMENT & PRODUCTS 1.6% Eastman Kodak Co. ........................................ United States 4,062,175 12,024,038 Mattel Inc. .............................................. United States 3,330,392 53,452,792 -------------- 65,476,830 -------------- LIFE SCIENCES TOOLS & SERVICES 0.6% (b) Thermo Fisher Scientific Inc. ............................ United States 575,370 23,457,835 -------------- MACHINERY 0.2% (b, e, f, g) Motor Coach Industries International Inc. ................ United States 5,548 7,215,174 --------------
22 | Semiannual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS/RIGHTS VALUE -------------- ---------------- -------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MARINE 0.8% A.P. Moller - Maersk AS .................................. Denmark 5,611 $ 33,605,763 -------------- MEDIA 7.7% (b) Adelphia Recovery Trust .................................. United States 48,268,724 1,206,718 (b, c) Adelphia Recovery Trust, Arahova Contingent Value Vehicle, Contingent Distribution ......................... United States 6,161,087 1,170,607 (b, c) Century Communications Corp., Contingent Distribution .... United States 16,986,000 -- Comcast Corp., A ......................................... United States 8,218,025 115,874,153 News Corp., A ............................................ United States 10,660,157 97,114,030 (i) Time Warner Cable Inc. ................................... United States 1,344,826 42,590,639 (b, d) TVMAX Holdings Inc. ...................................... United States 133,855 -- Virgin Media Inc. ........................................ United Kingdom 5,915,097 55,306,157 -------------- 313,262,304 -------------- METALS & MINING 0.1% (b, e, g) PMG LLC .................................................. United States 29,737 2,542,518 -------------- MULTI-UTILITIES 0.0% (b, c) NorthWestern Corp., Contingent Distribution .............. United States 11,805,000 -- -------------- OIL & GAS & CONSUMABLE FUELS 0.3% Noble Energy Inc. ........................................ United States 213,490 12,589,504 -------------- PAPER & FOREST PRODUCTS 3.5% (b, g) Domtar Corp. ............................................. United States 2,293,085 38,019,349 MeadWestvaco Corp. ....................................... United States 1,560,233 25,603,423 Weyerhaeuser Co. ......................................... United States 2,583,085 78,603,277 -------------- 142,226,049 -------------- PHARMACEUTICALS 6.8% Novartis AG .............................................. Switzerland 1,185,468 48,033,868 Schering-Plough Corp. .................................... United States 3,467,795 87,111,010 Wyeth .................................................... United States 3,077,520 139,688,633 -------------- 274,833,511 -------------- REAL ESTATE INVESTMENT TRUSTS (REITS) 0.7% Alexander's Inc. ......................................... United States 38,800 10,460,480 Ventas Inc. .............................................. United States 608,900 18,181,754 Vornado Realty Trust ..................................... United States 2,500 112,575 -------------- 28,754,809 -------------- REAL ESTATE MANAGEMENT & DEVELOPMENT 1.2% (b, d) Canary Wharf Group PLC ................................... United Kingdom 10,069,634 28,994,127 (b) The St. Joe Co. .......................................... United States 726,998 19,258,177 -------------- 48,252,304 -------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 1.2% (b) LSI Corp. ................................................ United States 10,548,673 48,101,949 -------------- SOFTWARE 3.5% (j) Microsoft Corp. .......................................... United States 5,940,840 141,213,767 --------------
Semiannual Report | 23 Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS/RIGHTS VALUE -------------- ---------------- -------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 8.5% Altria Group Inc. ........................................ United States 4,012,788 $ 65,769,595 British American Tobacco PLC ............................. United Kingdom 2,620,106 72,122,889 Imperial Tobacco Group PLC ............................... United Kingdom 3,583,024 93,028,288 Japan Tobacco Inc. ....................................... Japan 12,406 38,881,403 KT&G Corp. ............................................... South Korea 69,985 3,952,714 Lorillard Inc. ........................................... United States 652,700 44,233,479 Reynolds American Inc. ................................... United States 740,974 28,616,416 -------------- 346,604,784 -------------- TRANSPORTATION INFRASTRUCTURE 0.0%(a) (b) Groupe Eurotunnel SA ..................................... France 14,883 84,335 (b) Groupe Eurotunnel SA, wts., 12/30/11 ..................... France 1,570,655 248,939 -------------- 333,274 -------------- WIRELESS TELECOMMUNICATION SERVICES 0.1% Vodafone Group PLC ....................................... United Kingdom 3,152,977 6,080,044 -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $3,792,480,514) 3,376,162,799 -------------- PREFERRED STOCKS 1.9% DIVERSIFIED FINANCIAL SERVICES 0.9% Citigroup Inc., 8.125%, pfd., AA ......................... United States 1,403,293 26,213,513 Citigroup Inc., 8.50%, pfd., F ........................... United States 677,100 12,648,228 -------------- 38,861,741 -------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(a) (b, e) PTV Inc., 10.00%, pfd., A ................................ United Kingdom 114,246 27,419 -------------- MACHINERY 1.0% (b, e, f, g) Motor Coach Industries International Inc., pfd. .......... United States 39,804 39,804,000 -------------- TOTAL PREFERRED STOCKS (COST $57,167,841) 78,693,160 -------------- OPTIONS PURCHASED 0.2% PUT OPTIONS 0.2% (b) S&P 500 Index, exercise price $775, expiration date 12/19/09, contracts ................................... United States 1,525 3,965,000 (b) S&P 500 Index, exercise price $800, expiration date 12/19/09, contracts ................................... United States 1,533 4,599,000 -------------- TOTAL OPTIONS PURCHASED (COST $18,771,603) 8,564,000 --------------
PRINCIPAL AMOUNT(K) ---------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS 4.6% (l) Alliance Data Systems Corp., cvt., senior note, 144A, 4.75%, 5/15/14 ........................................ United States 20,193,000 20,822,819 American General Finance Corp., 5.85%, 6/01/13 ........................................ United States 1,283,000 736,767 senior note, J, 6.90%, 12/15/17 ....................... United States 17,960,000 9,737,822 (m) Calpine Corp., Exit Term Loan, FRN, 4.095%, 3/29/14 ...... United States 31,606,504 28,059,559 (e, n) Cerberus CG Investor I LLC, 12.00%, 7/31/14 .............. United States 18,089,600 3,437,024
24 | Semiannual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(K) VALUE -------------- ---------------- -------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS (CONTINUED) (e, n) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............. United States 18,089,600 $ 3,437,024 (e, n) Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............ United States 9,044,800 1,718,512 (e, n) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ...... United States 58,615,106 4,264,308 (g) DecisionOne Corp., (e) senior secured note, 15.00%, 11/30/13 ................. United States 1,500,292 1,675,075 (d) Term Loan B, 15.00%, 8/29/13 .......................... United States 263,440 294,130 (m) First Data Corp., Term Loan, FRN, 3.065%, 9/24/14, B-1 ................................................... United States 6,949,352 5,225,523 B-2 ................................................... United States 6,873,729 5,172,481 B-3 ................................................... United States 1,720,963 1,293,412 Groupe Eurotunnel SA, cvt., sub. bond, NRS I, T2, 3.00%, 7/28/09 .................................... France 21,700 EUR 24,349 T2, 3.00%, 7/28/09 .................................... France 24,211 GBP 41,827 T3, 3.00%, 7/28/10 .................................... France 5,574,500 EUR 6,255,035 T3, 3.00%, 7/28/10 .................................... France 5,182,586 GBP 8,953,527 (l) Indianapolis Downs LLC, 144A, senior secured note, 11.00%, 11/01/12 ................. United States 6,400,000 4,992,000 (o) senior secured sub. note, PIK, 15.50%, 11/01/13 ....... United States 27,032,056 15,137,951 (d, f, m) International Automotive Components Group NA Inc., Revolver, FRN, 5.75%, 1/18/14 ......................... United States 1,283,013 1,283,013 (e, f, n) International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............................................... United States 1,947,800 883,781 (e, f, m, p) Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 .... United States 22,458,139 21,549,777 (e, f, m, p) Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ................................... United States 3,561,931 6,205,171 (m) Realogy Corp., FRN, Delayed Draw Term B Loan, 4.177%, 10/10/13 ............ United States 853,815 622,675 Initial Term Loan B, 4.177%, 10/10/13 ................. United States 7,325,985 5,342,738 (q) Revolver, 3.427%, 4/10/13 ............................. United States 11,174,631 7,207,637 Synthetic Letter of Credit, 0.185%, 10/10/13 .......... United States 1,972,339 1,438,399 (m) Texas Competitive Electric Holdings Co. LLC, FRN, Initial Tranche B-1 Term Loan, 3.821%, 10/10/14 ....... United States 21,889,901 15,660,408 Term Loan B3, 3.821%, 10/10/14 ........................ United States 5,133,131 3,679,813 Tranche B-2 Term Loan, 3.821%, 10/10/14 ............... United States 3,416,321 2,449,718 (d, o) TVMAX Holdings Inc., PIK, 11.50%, 9/30/09 ....................................... United States 693,408 194,713 14.00%, 9/30/09 ....................................... United States 1,060,311 286,402 -------------- TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS (COST $325,005,870) 188,083,390 -------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS IN REORGANIZATION 1.5% (m, n) Charter Communications Operating LLC, FRN, Incremental Term Loan, 9.25%, 3/06/14 ................. United States 5,124,281 5,050,620 Term Loan B, 6.25%, 3/06/14 ........................... United States 29,741,613 26,971,925 (d, n) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ............................................... United States 50,000 250 (m, n) Smurfit-Stone Container Canada Inc., Term Loan C-1, FRN, 2.44%, 11/01/11 .................................. Canada 3,245,737 2,975,260
Semiannual Report | 25 Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(K) VALUE -------------- ---------------- -------------- CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS IN REORGANIZATION (CONTINUED) (m, n) Smurfit-Stone Container Enterprises, FRN, L/C Deposit-Funded Commitment, 1.313%, 11/01/10 ....... United States 4,906,643 $ 4,497,758 Term Loan B, 2.44%, 11/01/11 .......................... United States 6,762,587 6,199,040 Term Loan C, 2.44%, 11/01/11 .......................... United States 12,316,696 11,290,309 (n) Trump Entertainment Resorts Inc., 8.50%, 6/01/15 ......... United States 17,380,260 2,237,709 -------------- TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS IN REORGANIZATION (COST $59,301,623) ........ 59,222,871 -------------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $4,252,727,451) ................................. 3,710,726,220 SHORT TERM INVESTMENTS 9.4% U.S. GOVERNMENT AND AGENCY SECURITIES 9.3% (r) FHLB, 7/01/09 ............................................ United States 13,900,000 13,900,000 (r) U.S. Treasury Bills, (i) 8/27/09 ............................................... United States 45,000,000 44,990,235 9/03/09 ............................................... United States 45,000,000 44,989,200 (i) 7/09/09 - 12/24/09 .................................... United States 275,000,000 274,772,660 -------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $378,546,178) ................................... 378,652,095 -------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $4,631,273,629) ................................. 4,089,378,315 --------------
SHARES ---------------- (s) INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.1% MONEY MARKET FUNDS (COST $4,052,179) 0.1% (t) Bank of New York Institutional Cash Reserve Fund, 0.12% ................................................. United States 4,052,179 4,011,657 -------------- TOTAL INVESTMENTS (COST $4,635,325,808) 100.6% ........... 4,093,389,972 OPTIONS WRITTEN (0.0)%(a) ................................ (1,170,180) SECURITIES SOLD SHORT (1.9)% ............................. (78,669,284) OTHER ASSETS, LESS LIABILITIES 1.3% ...................... 53,311,195 -------------- NET ASSETS 100.0% ........................................ $4,066,861,703 --------------
CONTRACTS ---------------- (u) OPTIONS WRITTEN (PREMIUMS RECEIVED $452,357) 0.0%(a) CALL OPTIONS 0.0%(a) SOFTWARE 0.0%(a) Microsoft Corp., Jul. 22 Calls, 7/18/09 .................. United States 5,940 $ 1,170,180 --------------
26 | Semiannual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES VALUE ---------------- -------------- (v) SECURITIES SOLD SHORT 1.9% DIVERSIFIED FINANCIAL SERVICES 1.0% Citigroup Inc. ........................................... United States 13,059,370 $ 38,786,329 -------------- PHARMACEUTICALS 0.9% Merck & Co. Inc. ......................................... United States 1,426,429 39,882,955 -------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $54,441,716) ....... $ 78,669,284 --------------
(a) Rounds to less than 0.1% of net assets. (b) Non-income producing. (c) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (d) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the aggregate value of these securities was $34,217,337, representing 0.84% of net assets. (e) See Note 9 regarding restricted securities. (f) See Note 14 regarding other considerations. (g) See Note 13 regarding holdings of 5% voting securities. (h) A portion or all of the security is on loan at June 30, 2009. See Note 1(g). (i) Security or a portion of the security has been segregated as collateral for securities sold short and open forward contracts. At June 30, 2009, the value of securities and/or cash pledged amounted to $174,471,900. (j) A portion or all of the security is held in connection with written option contracts open at period end. (k) The principal amount is stated in U.S. dollars unless otherwise indicated. (l) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Trustees. At June 30, 2009, the aggregate value of these securities was $40,952,770, representing 1.01% of net assets. (m) The coupon rate shown represents the rate at period end. (n) See Note 8 regarding credit risk and defaulted securities. (o) Income may be received in additional securities and/or cash. (p) See Note 1(f) regarding special purpose entities. (q) See Note 10 regarding unfunded loan commitments. (r) The security is traded on a discount basis with no stated coupon rate. (s) See Note 1(g) regarding securities on loan. (t) The rate shown is the annualized seven-day yield at period end. (u) See Note 1(c) regarding written options. (v) See Note 1(e) regarding securities sold short. At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(c).
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ------------- ----------- ---------- ------------ ------------ South Korean Won .... BANT Sell 2,245,713,660 $ 1,715,887 7/08/09 $ -- $ (46,619) South Korean Won .... BBU Sell 265,000,000 200,000 7/08/09 -- (7,980) South Korean Won .... BANT Buy 220,000,000 172,279 7/08/09 384 -- British Pound ....... SSBT Sell 13,058,535 20,037,063 7/13/09 -- (1,448,468) British Pound ....... BANT Sell 4,060,000 5,828,748 7/13/09 -- (851,271) British Pound ....... HSBC Sell 3,660,000 5,512,649 7/13/09 -- (509,239) British Pound ....... DBFX Sell 2,310,000 3,709,976 7/13/09 -- (90,725)
Semiannual Report | 27 Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ------------- ----------- ---------- ------------ ------------ British Pound ....... BBU Sell 540,000 $ 816,723 7/13/09 $ -- $ (71,752) British Pound ....... SSBT Buy 4,719,247 6,918,996 7/13/09 845,699 -- British Pound ....... BANT Buy 3,010,000 4,298,798 7/13/09 653,629 -- Norwegian Krone ..... BANT Sell 276,758,703 39,379,440 7/13/09 -- (3,627,432) Norwegian Krone ..... HAND Sell 155,000,000 21,941,621 7/13/09 -- (2,144,578) Norwegian Krone ..... BBU Sell 38,250,000 49,457,250 7/27/09 -- (4,193,097) Euro ................ BANT Sell 36,330,000 47,024,831 7/27/09 -- (3,932,479) Euro ................ HSBC Sell 10,031,773 13,844,894 7/27/09 -- (225,907) Euro ................ DBFX Sell 5,370,000 7,355,544 7/27/09 -- (176,544) Euro ................ BANT Sell 50,163,772 43,344,980 8/10/09 -- (2,833,319) Swiss Franc ......... SSBT Sell 17,345,890 14,879,509 8/10/09 -- (1,088,264) Swiss Franc ......... HSBC Sell 19,343,611 16,726,830 8/10/09 -- (1,079,946) Swiss Franc ......... HAND Sell 523,091 470,000 8/10/09 -- (11,532) Swiss Franc ......... DBFX Sell 565,590 510,000 8/10/09 -- (10,654) Swiss Franc ......... BBU Sell 564,993 510,000 8/10/09 -- (10,105) Swiss Franc ......... BBU Sell 28,927,910 43,555,452 8/12/09 -- (4,038,210) British Pound ....... DBFX Sell 4,370,000 7,113,486 8/12/09 -- (76,259) British Pound ....... SSBT Sell 34,601,004 45,718,379 8/13/09 -- (2,812,050) Euro ................ BANT Sell 9,380,000 12,132,582 8/13/09 -- (1,023,552) Euro ................ BBU Sell 700,000 934,654 8/13/09 -- (47,147) Euro ................ SSBT Buy 2,250,000 3,183,210 8/13/09 -- (27,421) Euro ................ HSBC Sell 1,299,442 1,813,306 8/13/09 -- (9,256) Euro ................ HAND Sell 159,999,079 24,628,776 8/19/09 -- (210,299) Norwegian Krone ..... HAND Buy 6,563,900 1,000,000 8/19/09 19,013 -- Norwegian Krone ..... BBU Sell 16,411,437 2,550,000 8/19/09 2,205 -- Norwegian Krone ..... DBFX Sell 24,355,876 3,860,000 8/19/09 78,869 -- Norwegian Krone ..... SSBT Sell 5,655,395 4,560,803 8/31/09 -- (304,023) Canadian Dollar ..... BANT Sell 732,600 586,244 8/31/09 -- (43,945) Canadian Dollar ..... SSBT Buy 4,648,535 3,967,023 8/31/09 31,692 -- Canadian Dollar ..... SSBT Sell 14,798,476 18,904,408 8/31/09 -- (1,850,426) Euro ................ BANT Sell 14,154,196 18,871,907 8/31/09 -- (979,326) Euro ................ HSBC Sell 1,240,000 1,681,465 8/31/09 -- (57,633) Euro ................ BBU Sell 2,975,000 4,215,628 8/31/09 43,196 -- Euro ................ DBFX Sell 1,300,000 1,859,715 8/31/09 36,467 -- Euro ................ SSBT Sell 53,400,000 75,313,224 9/10/09 -- (12,537,672) British Pound ....... BBU Sell 39,147,831 58,056,233 9/14/09 -- (6,347,094) British Pound ....... SSBT Sell 310,000 460,807 9/14/09 -- (49,184) British Pound ....... AESX Buy 2,410,000 3,926,693 9/14/09 38,074 -- British Pound ....... BANT Sell 20,500,000 26,220,931 9/14/09 -- (2,528,261) Euro ................ HSBC Sell 820,000 1,056,816 9/14/09 -- (93,152) Euro ................ SSBT Sell 690,000 886,940 9/14/09 -- (80,716) Euro ................ SSBT Buy 8,006,556 11,174,019 9/14/09 54,372 -- Euro ................ HSBC Sell 2,035,458 1,566,571 9/17/09 -- (62,663) Australian Dollar ... SSBT Sell 4,472,279 3,558,494 9/17/09 -- (21,236) Australian Dollar ... BANT Sell 1,883,121 1,488,476 9/17/09 -- (19,555) Australian Dollar ... SSBT Buy 33,600 26,742 9/17/09 153 -- Australian Dollar ... SSBT Sell 2,295,049,270 23,229,244 10/20/09 -- (623,507) Japanese Yen ........ BBU Sell 100,439,420 1,030,000 10/20/09 -- (13,880)
28 | Semiannual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ------------- ----------- ---------- ------------ ------------ Japanese Yen ........ HSBC Sell 181,185,240 $ 1,880,000 10/20/09 $ -- $ (3,082) Japanese Yen ........ SSBT Buy 178,000,000 1,808,135 10/20/09 41,843 -- Japanese Yen ........ BANT Buy 47,548,800 480,000 10/20/09 14,181 -- Japanese Yen ........ BANT Sell 47,767,500 500,000 10/20/09 3,546 -- Japanese Yen ........ DBFX Sell 92,840,300 980,000 10/20/09 15,098 -- Japanese Yen ........ AESX Sell 195,724,638 2,040,000 10/20/09 5,808 -- Japanese Yen ........ HAND Sell 264,002,772 45,776,381 10/23/09 -- (3,861,976) Danish Krone ........ BANT Sell 25,538,372 4,568,409 10/23/09 -- (233,368) Danish Krone ........ BBU Sell 14,621,320 2,670,000 10/23/09 -- (79,131) Danish Krone ........ SSBT Sell 1,000,000 179,888 10/23/09 -- (8,134) Danish Krone ........ BBU Buy 4,760,100 900,000 10/23/09 -- (4,996) Danish Krone ........ SSBT Buy 92,688,910 15,898,923 10/23/09 1,528,643 -- Danish Krone ........ HAND Buy 4,874,654 820,000 10/23/09 96,543 -- Danish Krone ........ BANT Sell 9,837,104 12,670,190 11/13/09 -- (1,123,791) Euro ................ HSBC Sell 3,290,000 4,402,990 11/13/09 -- (210,380) Euro ................ BBU Sell 24,500,000 34,045,200 11/30/09 -- (309,127) Euro ................ BONY Sell 5,524,000 7,667,864 11/30/09 -- (77,985) Euro ................ SSBT Sell 991,431 1,375,918 11/30/09 -- (14,284) ---------- ------------ Unrealized appreciation (depreciation) ............................................ 3,509,415 (62,142,632) ---------- ------------ Net unrealized appreciation (depreciation) ..................................... $(58,633,217) ============
See Abbreviations on page 51. The accompanying notes are an integral part of these financial statements. Semiannual Report | 29 Mutual Beacon Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers ............................. $4,435,589,221 Cost - Controlled affiliated issuers (Note 13) .......... 2,081,593 Cost - Non-controlled affiliated issuers (Note 13) ...... 197,654,994 -------------- Total cost of investments ............................... $4,635,325,808 ============== Value - Unaffiliated issuers ............................ $3,939,233,340 Value - Controlled affiliated issuers (Note 13) ......... 2,542,518 Value - Non-controlled affiliated issuers (Note 13) ..... 151,614,114 -------------- Total value of investments (includes securities loaned in the amount of $3,887,012) ......................... 4,093,389,972 Cash ....................................................... 947,684 Cash on deposit with brokers ............................... 105,514,570 Foreign currency, at value (cost $30,452,995) .............. 30,339,224 Receivables: Investment securities sold .............................. 11,833,638 Capital shares sold ..................................... 1,718,435 Dividends and interest .................................. 8,246,730 Unrealized appreciation on forward exchange contracts ...... 3,509,415 Other assets ............................................... 5,851 -------------- Total assets ......................................... 4,255,505,519 -------------- Liabilities: Payables: Investment securities purchased ......................... 29,894,736 Capital shares redeemed ................................. 6,225,156 Affiliates .............................................. 4,049,748 Options written, at value (premiums received $452,357) ..... 1,170,180 Securities sold short, at value (proceeds $54,441,716) ..... 78,669,284 Payable upon return of securities loaned ................... 4,052,179 Unrealized depreciation on forward exchange contracts ...... 62,142,632 Unrealized depreciation on unfunded loan commitments (Note 10) ............................................... 324,568 Accrued expenses and other liabilities ..................... 2,115,333 -------------- Total liabilities .................................... 188,643,816 -------------- Net assets, at value .............................. $4,066,861,703 ============== Net assets consist of: Paid-in capital ............................................ $5,396,891,388 Undistributed net investment income ........................ 98,307,916 Net unrealized appreciation (depreciation) ................. (625,849,802) Accumulated net realized gain (loss) ....................... (802,487,799) -------------- Net assets, at value .............................. $4,066,861,703 ==============
The accompanying notes are an integral part of these financial statements. 30 | Semiannual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ....................................... $2,020,390,802 ============== Shares outstanding ......................................... 208,542,507 ============== Net asset value and maximum offering price per share ....... $ 9.69 ============== CLASS A: Net assets, at value ....................................... $1,592,988,467 ============== Shares outstanding ......................................... 166,265,682 ============== Net asset value per share(a) ............................... $ 9.58 ============== Maximum offering price per share (net asset value per share / 94.25%) ......................................... $ 10.16 ============== CLASS B: Net assets, at value ....................................... $ 61,385,024 ============== Shares outstanding ......................................... 6,660,021 ============== Net asset value and maximum offering price per share(a) .... $ 9.22 ============== CLASS C: Net assets, at value ....................................... $ 392,097,410 ============== Shares outstanding ......................................... 41,751,497 ============== Net asset value and maximum offering price per share(a) .... $ 9.39 ==============
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. Semiannual Report | 31 Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends: (net of foreign taxes of $3,022,934) Unaffiliated issuers .................................... $ 58,618,151 Non-controlled affiliated issuers (Note 13) ............. 237,796 Interest: Unaffiliated issuers .................................... 11,172,157 Reserve for uncollectible interest (Note 8) ............. (23,574,181) Non-controlled affiliated issuers (Note 13) ............. 96,611 Income from securities loaned .............................. 17,584 -------------- Total investment income .............................. 46,568,118 -------------- Expenses: Management fees (Note 3a) .................................. 11,514,630 Administrative fees (Note 3b) .............................. 1,469,596 Distribution fees: (Note 3c) Class A ................................................. 2,346,852 Class B ................................................. 317,327 Class C ................................................. 1,878,127 Transfer agent fees (Note 3e) .............................. 2,916,508 Custodian fees (Note 4) .................................... 160,968 Reports to shareholders .................................... 160,035 Registration and filing fees ............................... 134,120 Professional fees .......................................... 470,475 Trustees' fees and expenses ................................ 95,395 Dividends on securities sold short ......................... 748,290 Stock loan fees ............................................ 16,186,763 Other ...................................................... 109,500 -------------- Total expenses ....................................... 38,508,586 Expense reductions (Note 4) .......................... (50,406) -------------- Net expenses ...................................... 38,458,180 -------------- Net investment income .......................... 8,109,938 -------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ................................. (509,575,058) Non-controlled affiliated issuers (Note 13) .......... (389,754) Written options ......................................... 2,981,191 Foreign currency transactions ........................... 89,518,746 Securities sold short ................................... (5,456,023) -------------- Net realized gain (loss) .......................... (422,920,898) -------------- Net change in unrealized appreciation (depreciation) on: Investments ............................................. 758,537,346 Translation of other assets and liabilities denominated in foreign currencies .................... (113,240,238) -------------- Net change in unrealized appreciation (depreciation) .................................. 645,297,108 -------------- Net realized and unrealized gain (loss) ....................... 222,376,210 -------------- Net increase (decrease) in net assets resulting from operations ................................................. $ 230,486,148 ==============
The accompanying notes are an integral part of these financial statements. 32 | Semiannual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED JUNE 30, 2009 YEAR ENDED (UNAUDITED) DECEMBER 31, 2008 ---------------- ----------------- Increase (decrease) in net assets: Operations: Net investment income ........................................ $ 8,109,938 $ 101,243,085 Net realized gain (loss) from investments, written options, securities sold short and foreign currency transactions ... (422,920,898) (352,770,296) Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ......................... 645,297,108 (2,671,184,670) -------------- --------------- Net increase (decrease) in net assets resulting from operations ............................................. 230,486,148 (2,922,711,881) -------------- --------------- Distributions to shareholders from: Net investment income: Class Z ................................................... -- (6,619,057) Class A ................................................... -- (4,290,717) Class B ................................................... -- (137,348) Class C ................................................... -- (771,400) Net realized gains: Class Z ................................................... -- (97,668,819) Class A ................................................... -- (73,463,233) Class B ................................................... -- (3,969,920) Class C ................................................... -- (21,432,695) -------------- --------------- Total distributions to shareholders ............................. -- (208,353,189) -------------- --------------- Capital share transactions: (Note 2) Class Z ................................................... (102,666,416) (299,359,816) Class A ................................................... (152,913,908) 142,074,388 Class B ................................................... (14,867,145) (34,340,619) Class C ................................................... (45,317,173) (110,542,023) -------------- --------------- Total capital share transactions ................................ (315,764,642) (302,168,070) -------------- --------------- Redemption fees ................................................. -- 19,698 -------------- --------------- Net increase (decrease) in net assets ..................... (85,278,494) (3,433,213,442) Net assets: Beginning of period ............................................. 4,152,140,197 7,585,353,639 -------------- --------------- End of period ................................................... $4,066,861,703 $ 4,152,140,197 -------------- --------------- Undistributed net investment income included in net assets: End of period ................................................... $ 98,307,916 $ 90,197,978 ============== ===============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 33 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual Beacon Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Senior secured corporate loans with floating or variable interest rates generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from loan dealers and other financial institutions, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services use independent market quotations from loan dealers or financial institutions and may incorporate valuation methodologies that consider multiple bond characteristics such as dealer quotes, issuer type, coupon, maturity, weighted average maturity, interest rate spreads and yield curves, cash flow and credit risk/quality analysis, to determine current value. 34 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Semiannual Report | 35 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) B. FOREIGN CURRENCY TRANSLATION (CONTINUED) Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. The Fund purchases or writes option contracts in order to manage equity price risk. An option is a contract entitling the holder to purchase or sell a specific amount of shares or units of a particular security, currency or index at a specified price. Options purchased are recorded as an asset while options written are recorded as a liability. Upon exercise of an option, the acquisition cost or sales proceeds of the security is adjusted by any premium paid or received. Upon expiration of an option, any premium paid or received is recorded as a realized loss or gain. Upon closing an option other than through expiration or exercise, the difference between the premium and the cost to close the position is recorded as a realized gain or loss. See Note 12 regarding other derivative information. 36 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. E. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund incurs a loss if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit with broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay stock loan fees for borrowing the securities sold short and is required to pay the counterparty any dividends or interest due on the securities sold short. Such dividends or interest and any stock loan fees are recorded as an expense to the Fund. F. SPECIAL PURPOSE ENTITIES At June 30, 2009, the Fund contributed an additional $14,140,905 as a subordinated note holder of certain special purpose entities ("SPEs"). Such contributions, while made at the discretion of the Fund, represent additional capital contributions to the SPE in support of its underlying investments and are subject first to the claims of the senior note holders of the SPE. These contributions are recorded as an addition to the Fund's cost basis in the SPE and are subject to the risk of loss in the event of continued unfavorable market conditions related to the SPE's underlying investments. G. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. Semiannual Report | 37 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. 38 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. K. REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the Fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. L. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ---------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ------------ ------------- ----------- ------------- CLASS Z SHARES: Shares sold .................... 5,443,544 $ 49,089,751 11,250,144 $ 136,618,769 Shares issued in reinvestment of distributions ................ -- -- 7,467,999 96,562,887 Shares redeemed ................ (17,576,315) (151,756,167) (45,025,975) (532,541,472) ----------- ------------- ----------- ------------- Net increase (decrease) ........ (12,132,771) $(102,666,416) (26,307,832) $(299,359,816) =========== ============= =========== ============= CLASS A SHARES: Shares sold .................... 13,109,091 $ 114,350,343 83,093,593 $ 933,681,282 Shares issued in reinvestment of distributions ............... -- -- 5,456,844 69,956,428 Shares redeemed ................ (31,441,923) (267,264,251) (73,885,362) (861,563,322) ----------- ------------- ----------- ------------- Net increase (decrease) ........ (18,332,832) $(152,913,908) 14,665,075 $ 142,074,388 =========== ============= =========== =============
Semiannual Report | 39 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST (CONTINUED)
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ---------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ------------ ------------- ----------- ------------- CLASS B SHARES: Shares sold .................... 69,084 $ 593,866 253,906 $ 3,096,427 Shares issued in reinvestment of distributions ............... -- -- 305,496 3,788,152 Shares redeemed ................ (1,842,937) (15,461,011) (3,422,951) (41,225,198) --------- ------------ ----------- ------------- Net increase (decrease) ........ (1,773,853) $(14,867,145) (2,863,549) $ (34,340,619) ========== ============ =========== ============= CLASS C SHARES: Shares sold .................... 1,365,952 $ 11,776,965 5,583,255 $ 66,138,537 Shares issued in reinvestment of distributions ............... -- -- 1,572,454 19,859,013 Shares redeemed ................ (6,851,447) (57,094,138) (16,485,614) (196,539,573) ---------- ------------ ----------- ------------- Net increase (decrease) ........ (5,485,495) $(45,317,173) (9,329,905) $(110,542,023) ========== ============ =========== =============
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- ------------------------------------------------- 0.600% Up to and including $5 billion 0.570% Over $5 billion, up to and including $7 billion 0.550% Over $7 billion, up to and including $10 billion 0.540% In excess of $10 billion
40 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- --------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ........... 0.35% Class B ........... 1.00% Class C ........... 1.00%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................. $185,417 Contingent deferred sales charges retained ...... $ 15,882
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $2,916,508, of which $1,876,571 was retained by Investor Services. Semiannual Report | 41 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. During the period ended June 30, 2009, the Fund's projected benefit obligation and benefit payments under the Plan were as follows: (a) Projected benefit obligation at June 30, 2009 ....... $149,734 (b) Increase in projected benefit obligation ............ $ 6,668 Benefit payments made to retired trustees ........... $ 3,227
(a) The projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is included in trustees' fees and expenses in the Statement of Operations. 6. INCOME TAXES For tax purposes, capital losses may be carried over to offset future capital gains, if any. At December 31, 2008, the Fund had tax basis capital losses of $100,024,292 expiring in 2016. For tax purposes, realized capital losses and realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses and realized currency losses of $101,600,195 and $24,314,235, respectively. At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ............................... $ 4,694,916,800 --------------- Unrealized appreciation ........................... $ 543,854,282 Unrealized depreciation ........................... (1,145,381,110) --------------- Net unrealized appreciation (depreciation) ........ $ (601,526,828) ---------------
42 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 6. INCOME TAXES (CONTINUED) Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, pass-through entity income, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, bond discounts and premiums, pass-through entity income, and certain dividends on securities sold short. 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $996,245,862 and $1,202,296,455, respectively. Transactions in options written during the period ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED --------- ----------- Options outstanding at December 31, 2008 .... 103,032 $ 3,770,958 Options written ............................. 17,025 2,625,533 Options expired ............................. (7,609) (1,555,731) Options exercised ........................... (7,200) (514,297) Options closed .............................. (99,308) (3,874,106) ------- ----------- Options outstanding at June 30, 2009 ........ 5,940 $ 452,357 ------- -----------
8. CREDIT RISK AND DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. If it becomes probable that income on debt securities, including those of distressed companies, will not be collected, the Fund discontinues accruing income and recognizes a reserve for uncollectible interest. At June 30, 2009, the aggregate value of distressed company securities and securities for which interest has been discontinued was $72,963,520, representing 1.79% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. Semiannual Report | 43 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ------------------------------------ ------------------ ----------- ------------ 484,720 AboveNet Inc. ...................... 10/02/01 - 8/08/08 $25,693,460 $ 39,252,626 613 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ......................... 4/17/06 - 9/08/06 -- 36,798 19,829 AboveNet Inc., wts., 9/08/10 ....... 10/02/01 - 9/07/07 2,071,196 1,140,168 15,831,950 CB FIM Coinvestors LLC ............. 1/15/09 - 6/02/09 15,831,950 36,147,508 20,610,629 Cerberus CG Investor I LLC ......... 7/26/07 - 6/17/08 20,540,041 3,916,020 18,089,600 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ................. 7/26/07 18,089,600 3,437,024 20,610,629 Cerberus CG Investor II LLC ........ 7/26/07 - 6/17/08 20,540,040 3,916,020 18,089,600 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ................. 7/26/07 18,089,600 3,437,024 10,305,315 Cerberus CG Investor III LLC ....... 7/26/07 - 6/17/08 10,270,020 1,958,010 9,044,800 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ................. 7/26/07 9,044,800 1,718,512 19,805,560 Cerberus FIM Investors Holdco LLC .. 11/20/06 19,805,560 1,441,845 58,615,106 Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ................ 11/20/06 58,615,105 4,264,308 1,142,353 (a) DecisionOne Corp. .................. 3/12/99 - 7/18/00 793,798 1,884,882 1,500,292 (a) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 .......... 6/01/09 1,500,292 1,675,075 627,237 (a) DecisionOne Corp., wts., 6/08/17 ... 7/09/07 -- -- 35,242 FE Capital Holdings Ltd. ........... 8/29/03 - 3/11/08 4,098,788 -- 1,157,143 First Chicago Bancorp .............. 11/16/06 16,200,002 2,918,455 225,943 IACNA Investor LLC ................. 7/24/08 231,388 2,259 2,846,329 International Automotive Components Group Brazil LLC ..... 4/13/06 - 12/26/08 1,909,386 2,548,719 378,194 International Automotive Components Group Japan LLC ...... 9/26/06 - 3/27/07 3,283,337 1,046,196 10,149,082 (b) International Automotive Components Group LLC ............ 1/12/06 - 10/16/06 10,151,710 2,302,827 1,947,800 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ......................... 3/30/07 1,977,017 883,781
44 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- ------------------------------------ ------------------ ----------- ------------ 6,469,827 International Automotive Components Group NA LLC, A ................. 3/30/07 - 10/10/07 $ 6,404,397 $ 246,500 5,548 Motor Coach Industries International Inc. .............. 4/17/09 6,387,469 7,215,174 39,804 Motor Coach Industries International Inc., pfd. ........ 4/17/09 39,804,000 39,804,000 163,895 NCB Warrant Holdings Ltd., A ....... 12/16/05 - 3/11/08 1,725,660 -- 106,700 Olympus Re Holdings Ltd. ........... 12/19/01 10,318,072 233,182 29,737 PMG LLC ............................ 3/22/04 2,081,593 2,542,518 22,458,139 Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ............ 1/22/08 - 2/12/08 31,249,433 21,549,777 3,561,931 Pontus II Trust, junior profit- participating note, 144A, FRN, 7.66%, 6/25/09 .................. 2/29/08 8,911,542 6,205,171 114,246 PTV Inc., 10.00%, pfd., A .......... 12/07/01 - 3/06/02 71,975 27,419 4,450,920 Symetra Financial .................. 7/27/04 51,160,000 65,250,487 ------------ TOTAL RESTRICTED SECURITIES (6.32% of Net Assets) ..................... $257,002,285 ============
(a) The Fund also invests in unrestricted securities of the issuer, valued at $294,130 as of June 30, 2009. (b) The Fund also invests in unrestricted securities of the issuer, valued at $1,283,013 as of June 30, 2009. 10. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. Funded portions of credit agreements are presented on the Statements of Investments. At June 30, 2009, unfunded commitments were as follows:
UNFUNDED COMMITMENT ---------- BORROWER Realogy Corp., FRN, Revolver, 3.427%, 4/10/13 ........... $2,564,669 ----------
Unfunded loan commitments and funded portions of credit agreements are marked to market daily and any unrealized appreciation or depreciation is included in the Statement of Assets and Liabilities and Statement of Operations. 11. UNFUNDED CAPITAL COMMITMENTS The Fund may enter into certain capital commitments and may be obligated to perform on such agreements at a future date. Unfunded capital commitments requiring recognition are monitored for impairment and any unrealized deprecation is included in the Statement of Assets and Liabilities and the Statement of Operations. At June 30, 2009, the Fund had aggregate unfunded capital commitments of $63,696,598, for which no depreciation has been recognized. Semiannual Report | 45 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 12. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS ASSET DERIVATIVES LIABILITY DERIVATIVES HEDGING INSTRUMENTS --------------------------------------- ----------------------------------------- UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ---------- -------------------------- ------------ Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $3,509,415 forward exchange contracts $62,142,632 Equity contracts ... Investments, at value 8,600,798 Options written, at value 1,170,180
For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- --------------------------------------------- -------------- -------------- ------------- Foreign exchange contracts ....... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $89,507,576 $(113,234,424) 950,543,151 Equity contracts ... Net realized gain (loss) from investments and written options/Net change in unrealized appreciation (depreciation) on investments 792,392 (10,686,611) 25,352
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(c) regarding derivative financial instruments. 46 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund period ended June 30, 2009, were as shown below.
NUMBER OF NUMBER OF SHARES/WARRANTS/ SHARES/WARRANTS/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME GAIN (LOSS) - -------------- ----------------- ---------- ----------- ---------------- ------------ ---------- ----------- CONTROLLED AFFILIATES(a) PMG, LLC ...................... 29,737 -- -- 29,737 $ 2,542,518 $ -- $ -- ------------ ---------- --------- NON-CONTROLLED AFFILIATES CB FIM Coinvestors LLC ........ -- 15,831,950 -- 15,831,950 $36,147,508 $ -- $ -- DecisionOne Corp. ............. 1,142,353 -- -- 1,142,353 1,884,882 -- -- DecisionOne Corp., 12.00%, 4/15/10 .................... 1,470,406 29,886 1,500,292 -- -- 88,675 (389,754) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 ................... -- 1,500,292 -- 1,500,292 1,675,075 -- -- DecisionOne Corp., Term Loan B, 15.00%, 8/29/13 ............ 263,440 -- -- 263,440 294,130 7,936 -- DecisionOne Corp., wts., 6/08/17 .................... 627,237 -- -- 627,237 -- -- -- Domtar Corp. .................. 21,549,115 5,967,910 (25,223,940) 2,293,085(b) 38,019,349 -- -- Farmer Brothers Co. ........... 1,033,896 -- -- 1,033,896 23,655,541 237,796 -- FE Capital Holdings Ltd. ...... 35,242 -- -- 35,242 -- -- -- First Chicago Bancorp ......... 1,157,143 -- -- 1,157,143 2,918,455 -- -- Motor Coach Industries International Inc. ......... -- 5,548 -- 5,548 7,215,174 -- -- Motor Coach Industries International Inc., pfd .... -- 39,804 -- 39,804 39,804,000 -- -- ------------ ---------- --------- TOTAL NON-CONTROLLED AFFILIATES $151,614,114 $ 334,407 $(389,754) ------------ ---------- --------- TOTAL AFFILIATED SECURITIES (3.79% of Net Assets) $154,156,632 $ 334,407 $(389,754) ============ ========== =========
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. (b) Reflects a 1 for 12 reverse stock split during the current year. 14. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Semiannual Report | 47 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 14. OTHER CONSIDERATIONS (CONTINUED) Franklin Mutual serves as investment manager to certain special purpose entities that issue securities held by the Fund. Franklin Mutual is not compensated for such services and does not invest in or exercise control over such entities. As investment manager, Franklin Mutual is primarily responsible for recommending investments in unaffiliated issuers to be held by the special purpose entities. Securities issued by these special purpose entities are restricted under the Securities Act of 1933 and are deemed to be illiquid. 15. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $13,132 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statement of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 16. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. 48 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS (CONTINUED) The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL -------------- ------------ ------------ -------------- ASSETS: Investments in Securities: Equity Investments:(a) Airlines ................................ $ 1,498,775 $ 22,650 $ -- $ 1,521,425 Auto Components ......................... -- -- 6,161,566 6,161,566 Chemicals ............................... 15,977,490 -- 3,149,637 19,127,127 Commercial Banks ........................ 41,955,819 -- 2,918,455 44,874,274 Commercial Services and Supplies ........ 8,928 -- --(b) 8,928 Computers & Peripherals ................. 83,118,388 -- 1,884,882 85,003,270 Consumer Finance ........................ -- -- 47,379,403 47,379,403 Diversified Financial Services .......... 57,384,252 -- --(b) 57,384,252 Diversified Telecommunication Services .. 193,196,188 1,167,587 --(b) 194,363,775 Insurance ............................... 288,545,175 -- 65,483,669 354,028,844 Machinery ............................... -- -- 47,019,174 47,019,174 Media ................................... 310,884,979 2,377,325 --(b) 313,262,304 Metals & Mining ......................... -- -- 2,542,518 2,542,518 Multi-Utilities ......................... -- -- --(b) -- Real Estate Management & Development .... 19,258,177 -- 28,994,127 48,252,304 All other Equity Investments(c) ......... 2,233,926,795 -- -- 2,233,926,795 Options Purchased .......................... 8,564,000 -- -- 8,564,000 Corporate Bonds, Notes & Senior Floating Rate Interests ................. -- 142,854,460 45,228,930 188,083,390 Corporate Bonds, Notes & Senior Floating Rate Interests in Reorganization ........ -- 59,222,621 250 59,222,871 Short Term Investments ..................... 364,752,095 17,911,657 -- 382,663,752 -------------- ------------ ------------ -------------- Total Investments in Securities ......... $3,619,071,061 $223,556,300 $250,762,611 $4,093,389,972 ============== ============ ============ ============== Forward Exchange Contracts .................... $ -- $ 3,509,415 $ -- $ 3,509,415 LIABILITIES: Options Written ............................... 1,170,180 -- -- 1,170,180 Securities Sold Short ......................... 78,669,284 -- -- 78,669,284 Forward Exchange Contracts .................... -- 62,142,632 -- 62,142,632 Unfunded Loan Commitments ..................... -- 324,568 -- 324,568
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. Semiannual Report | 49 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS (CONTINUED) At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN UNREALIZED APPRECIATION NET CHANGE (DEPRECIATION) IN ATTRIBUTABLE NET UNREALIZED NET TRANSFER TO ASSETS BEGINNING REALIZED APPRECIATION PURCHASES IN (OUT) OF ENDING STILL HELD BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) LEVEL 3 BALANCE AT PERIOD END ------------ ------------ -------------- ----------- ------------- ------------ -------------- ASSETS Investments in Securities: Equity Investments:(a) Auto Components ......... $ 5,470,297 $ -- $ 700,783 $ (9,514) $ -- $ 6,161,566 $ 700,783 Chemicals ............... 3,149,637 -- -- -- -- 3,149,637 -- Commercial Banks ........ 8,776,047 -- (5,857,592) -- -- 2,918,455 (5,857,592) Commercial Services & Supplies ............. -- -- -- -- -- --(b) -- Computers & Peripherals .......... -- -- 1,884,882 -- -- 1,884,882 1,884,882 Consumer Finance ........ 14,444,319 -- 17,279,605 15,655,479 -- 47,379,403 17,279,605 Diversified Financial Services ............. -- -- -- -- -- --(b) -- Diversified Telecommunication Services ............. 24,316,695 -- 14,534,385 -- (38,851,081) --(b) -- Health Care Providers & Services ............. 20,437,039 -- (9,731,930) -- (10,705,109) -- -- Insurance ............... 59,403,216 -- 6,080,454 -- -- 65,483,669 6,080,454 Machinery ............... -- -- 827,705 46,191,469 -- 47,019,174 827,705 Media ................... -- -- -- -- -- --(b) -- Metals & Mining ......... 2,825,020 -- (282,502) -- -- 2,542,518 (282,502) Multi-Utilities ......... -- -- -- -- -- --(b) -- Real Estate Management & Development .......... 38,815,143 -- (9,821,016) -- -- 28,994,127 (9,821,016) Corporate Bonds, Notes & Senior Floating Rate Interests ............... 51,521,796 (389,754) (1,434,733) (4,468,379) -- 45,228,930 (1,824,487) Corporate Bonds, Notes & Senior Floating Rate Interests in Reorganization .......... 919,813 (27,296,152) 32,764,058 (6,387,469) -- 250 -- ------------ ------------ ------------ ----------- ------------ ------------ ----------- TOTAL ................... $230,079,022 $(27,685,906) $ 46,944,099 $50,981,586 $(49,556,190) $250,762,611 $ 8,987,832 ============ ============ ============ =========== ============ ============ ===========
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. 50 | Semiannual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 17. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 18, 2009 and determined that no events have occurred that require disclosure. ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound SELECTED PORTFOLIO FHLB - Federal Home Loan Bank FRN - Floating Rate Note L/C - Letter of Credit PIK - Payment-In-Kind COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 51 Mutual Beacon Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. 52 | Semiannual Report Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counterparty credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and Semiannual Report | 53 Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) its long-term relationship with the Fund as reasons that shareholders choose to invest, and remain invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. 54 | Semiannual Report Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional multi-cap value funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the second-lowest performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the middle performing quintiles. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quintile and exceeded 3%, as shown in the Lipper Section 15(c) Report. The Board discussed with the investment manager the reasons for the relative underperformance for the one-year period ended December 31, 2008. While noting such discussions, the Board, overall, was satisfied with the comparative performance of the Fund. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's second-best, second-best and best performing quintiles of peer funds for the three-, five- and 10-year periods ended December 31, 2008, respectively. The trustees concluded that, while the Fund's losses over the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years and the reasons for any increases in the Fund's expense ratios. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Semiannual Report | 55 Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the middle quintile of its Lipper expense group and its total expenses were in the middle quintile of such group. The Board was satisfied with such comparative expenses. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. 56 | Semiannual Report Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative relationship of investment management and underwriting expenses; shareholder servicing profitability; economies of scale; and the relative contribution of the Fund to the profitability of the investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. Semiannual Report | 57 Mutual Beacon Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004. The trustees assessed the savings to shareholders resulting from such breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor the appropriateness of the breakpoints. The trustees also considered the effects an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. 58 | Semiannual Report This page intentionally left blank. This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL BEACON FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B & C) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 476 S2009 08/09 JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" (GRAPHIC) GLOBAL MUTUAL GLOBAL DISCOVERY FUND (FORMERLY, MUTUAL DISCOVERY FUND) (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services.
MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ....................................................... 1 SEMIANNUAL REPORT Mutual Global Discovery Fund ............................................. 5 Performance Summary ...................................................... 11 Your Fund's Expenses ..................................................... 14 Financial Highlights and Statement of Investments ........................ 16 Financial Statements ..................................................... 31 Notes to Financial Statements ............................................ 35 Shareholder Information .................................................. 52
Shareholder Letter Dear Mutual Global Discovery Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In the U.S. and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. During the period, the U.S. unemployment rate rose to its highest level in 25 years, housing prices continued their precipitous declines and 30-year U.S. Treasury yields plummeted to a 30-year low of around 2.5%, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of financial services companies on the scale of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of major bank nationalization was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The low in early March for the Standard & Poor's 500 Index -- down 26% from 2008 year-end and 57% from its peak in October 2007 -- was followed by a 42% rebound to its recent, second-quarter high on June 11.(1) The 57% drop was the third worst since 1900.(1) At the same time, yields on 30-year Treasuries shot up to (1). Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Standard & Poor's 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The index is one of the most widely used benchmarks of U.S. equity performance. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 4.8% in June, resulting in their worst six-month performance in over 16 years. European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed that the recovery in Europe would be slower than in the U.S. Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, the results of the government "stress test" of major financial institutions were generally positive, enabling many of those institutions to raise capital in the public markets and avoid a worst-case scenario of government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Additionally, the bankruptcies of General Motors and Chrysler, although particularly painful for dealers, suppliers and those directly dependent on the auto industry, were absorbed without triggering further systemic risk. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual Global Discovery Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities, attractive merger arbitrage situations, and distressed debt opportunities. Consistent with the expectations outlined in our 2008 year-end letter, we added to companies in economically defensive industries, with strong market positions, high barriers to entry, and reasonably predictable earnings and cash flows, including companies in the consumer staples sector and the health care sector. We also anticipated purchases in some economically sensitive industries, and likewise increased our investments in some energy companies where we believe we found good value. 2 | Not part of the semiannual report Late in 2008 and early in 2009, we began to find opportunities in senior secured corporate loans trading at levels we perceived reflected mispriced risk. These are exactly the types of opportunities that we patiently wait for and that we had not seen since the last big credit default cycle of 2001-2003, which included the frauds at Enron, Tyco and WorldCom. On the bankruptcy front recently, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we like, although we expect more of these as "covenant lite," highly leveraged balance sheets eventually reach a tipping point. On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. However, a few large health care deals did emerge as those acquirers took advantage of their relatively stable cash flows and strong balance sheets to pursue a needed rationalization of the industry. The good news here is that we believe the potential returns for these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do Not part of the semiannual report | 3 matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman - ----------------------------------- Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. 4 | Not part of the semiannual report Semiannual Report Mutual Global Discovery Fund (formerly, Mutual Discovery Fund) YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual Global Discovery Fund seeks capital appreciation by investing primarily in equity securities of companies of any nation the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 100% of its assets in foreign securities. We are pleased to bring you Mutual Global Discovery Fund's semiannual report for the period ended June 30, 2009. The Fund's goal and strategy have not changed; however, we changed the Fund's name to better reflect its strategy of seeking opportunities around the world. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. PERFORMANCE OVERVIEW Mutual Global Discovery Fund - Class Z delivered a +7.76% cumulative total return for the six months ended June 30, 2009. The Fund outperformed its benchmarks, the Morgan Stanley Capital International (MSCI) World Index and the Standard & Poor's 500 Index (S&P 500), which had +6.79% and +3.16% total returns for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the six months under review, global equities hit new bear market lows in March before delivering their biggest quarterly rally in more than a decade. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic (1). Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The MSCI World Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 21. Semiannual Report | 5 contraction, investors regained some risk appetite, rotating capital back into cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) U.S. 16.7% U.K. 11.6% France 11.3% Germany 4.6% Hong Kong 4.6% Switzerland 4.4% Norway 2.7% Denmark 2.0% South Korea 1.8% Bermuda 1.6% Netherlands 1.5% Italy 1.1% Japan 1.0% Mexico 1.0% Other 2.1% Short-Term Investments & Other Net Assets 32.0%
In the reporting period's final weeks, global equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. For example, initial U.S. jobless claims fell to their lowest levels in six months during May, but unemployment rose again at the end of the period to 9.5%.(2) In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(3) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(4) INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy (2.) Source: Bureau of Labor Statistics. (3.) Source: European Communities Eurostat. (4.) Source: People's Bank of China. 6 | Semiannual Report or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION During the first half of 2009, the Fund's top performers were Carlsberg, a leading European brewer headquartered in Denmark; Seadrill, a Norwegian deepwater contract driller; and Marine Harvest, a Norway-based salmon producer with far-reaching global operations. Carlsberg's share price almost doubled during the reporting period, due in part to diminishing concerns over a possible devaluation of the Russian ruble as oil prices strengthened in 2009's second quarter. Aside from currency-related influences, Carlsberg also delivered a very strong set of results, including excellent price momentum that more than offset a decline in sales volume; market share gains, especially in Russia, where the company now controls more than 40% of the beer market; and margin progression as the company delivered on its cost savings program. Also, market concerns about Carlsberg's balance sheet were successfully addressed by management, who remained focused on free cash flow generation and debt reduction. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Tobacco 12.3% Food Products 7.6% Pharmaceuticals 6.7% Beverages 6.1% Industrial Conglomerates 3.8% Energy Equipment & Services 3.7% Insurance 3.2% Commercial Banks 3.2% Media 2.4% Diversified Financial Services 1.9%
Semiannual Report | 7 Seadrill's share price benefited from the resilience of the deepwater drilling segment in terms of day rates. Brazilian national oil company Petrobras continued its multiyear effort to tender for additional deepwater offshore drilling rigs and develop the country's claim to the vast and recently discovered Tupi underwater oil field. According to our analysis, Seadrill is extremely well positioned in this regard because it still had some of its modern, highly specialized rigs available for use, while being among the very few suppliers not facing financing issues, and while also being able to deliver its equipment on schedule. At period-end, Seadrill was in the process of refinancing its debt and could begin paying a dividend in the second half of 2009. TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Schering-Plough Corp. 3.4% PHARMACEUTICALS, U.S. British American Tobacco PLC 3.3% TOBACCO, U.K. Wyeth 3.3% PHARMACEUTICALS, U.S. Imperial Tobacco Group PLC 2.8% TOBACCO, U.K. Danone 2.4% FOOD PRODUCTS, FRANCE Lorillard Inc. 2.2% TOBACCO, U.S. Carlsberg AS, A & B 2.0% BEVERAGES, DENMARK Pernod Ricard SA 2.0% BEVERAGES, FRANCE Eutelsat Communications 1.7% MEDIA, FRANCE Berkshire Hathaway Inc., A & B 1.7% INSURANCE, U.S.
Investor concerns about Chilean salmon production sent Marine Harvest's share price plunging in 2008. In our view, investors had forgotten that lower salmon supply would normally translate into higher prices. As salmon prices increased by more than 40% during the first half of 2009, Marine Harvest's cash flow increased and it regained investor interest. Besides operational gearing, financial gearing also positively affected Marine Harvest's share price. Largely as a result of these conditions, Marine Harvest's share price roughly quadrupled during the six-month period. As always, there were some detractors from Fund performance. These included U.K.-based Imperial Tobacco, a leading international tobacco company; Berkshire Hathaway, a U.S. conglomerate headed by Warren Buffet; and E-L Financial, a Canadian investment holding company. Imperial Tobacco shares declined after investors grew wary about the company's balance sheet and dividend policy, and they generally rotated away from typically defensive sectors as cyclical stocks rallied strongly during the second quarter. At period-end, we still believed Imperial shares were an attractive investment trading at a single-digit 2010 price-to-earnings multiple and boasting more than 10% in free cash flow yield. Berkshire Hathaway shares underperformed as investors switched into financials that were perceived to be more sensitive to the upside in capital markets. Investors also continued to exhibit concern over the long-term put options written by Berkshire that would be triggered if equity markets continued to sustain substantial declines. 8 | Semiannual Report E-L Financial has direct exposure to capital markets through its investment company United Corporations Ltd. and indirect exposure through its control of The Dominion of Canada General Insurance and The Empire Life Insurance companies. The stock suffered early in the year as a consequence of this capital markets exposure, but subsequently recovered somewhat through period-end. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual Global Discovery Fund. We look forward to serving your future investment needs. (PHOTO OF ANNE E. GUDEFIN) /s/ Anne E. Gudefin - ----------------------------------- Anne E. Gudefin, CFA Co-Portfolio Manager (PHOTO OF CHARLES M. LAHR) /s/ Charles M. Lahr - ----------------------------------- Charles M. Lahr, CFA Co-Portfolio Manager Mutual Global Discovery Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Semiannual Report | 9 ANNE GUDEFIN has been portfolio manager for Mutual Global Discovery Fund since 2005. She is also portfolio manager for Mutual Quest Fund, and has been a member of the management team of the Funds since 2000, when she joined Franklin Templeton Investments. Previously, she was an analyst at Perry Capital. CHARLES LAHR has been portfolio manager for Mutual Global Discovery Fund since 2007. He has also been portfolio manager for Mutual Financial Services Fund since 2004. He joined Franklin Templeton Investments in 2003. Previously, he was a senior analyst for the State of Wisconsin Investment Board and also worked for U.S. Bancorp and Principal Financial Group. 10 | Semiannual Report Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: MDISX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$1.75 $24.29 $22.54
CLASS A (SYMBOL: TEDIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$1.70 $24.00 $22.30
CLASS B (SYMBOL: TEDBX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$1.59 $23.48 $21.89
CLASS C (SYMBOL: TEDSX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$1.60 $23.76 $22.16
CLASS R (SYMBOL: TEDRX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$1.67 $23.79 $22.12
Semiannual Report | 11 Performance Summary (CONTINUED) PERFORMANCE CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z/R: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +7.76% -12.19% +44.15% +125.67% Average Annual Total Return(3) +7.76% -12.19% +7.59% +8.48% Value of $10,000 Investment(4) $10,776 $8,781 $14,415 $22,567 Total Annual Operating Expenses(5) 1.02%
CLASS A(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +7.62% -12.41% +41.95% +118.33% Average Annual Total Return(3) +1.44% -17.44% +6.00% +7.48% Value of $10,000 Investment(4) $10,144 $8,256 $13,381 $20,574 Total Annual Operating Expenses(5) 1.30%
CLASS B(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- -------- ------- ------- -------- Cumulative Total Return(2) +7.26% -13.08% +37.16% +107.11% Average Annual Total Return(3) +3.26% -16.40% +6.21% +7.55% Value of $10,000 Investment(4) $10,326 $8,360 $13,516 $20,711 Total Annual Operating Expenses(5) 2.02%
CLASS C(1) 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ---------- ------- ------ ------- -------- Cumulative Total Return(2) +7.22% -13.06% +37.13% +104.19% Average Annual Total Return(3) +6.22% -13.89% +6.52% +7.40% Value of $10,000 Investment(4) $10,622 $8,611 $13,713 $20,419 Total Annual Operating Expenses(5) 2.01%
INCEPTION CLASS R 6-MONTH 1-YEAR 5-YEAR (1/1/02) - ------- ------- ------ ------- --------- Cumulative Total Return(2) +7.55% -12.63% +40.64% +73.22% Average Annual Total Return(3) +7.55% -12.63% +7.06% +7.61% Value of $10,000 Investment(4) $10,755 $8,737 $14,064 $17,322 Total Annual Operating Expenses(5) 1.52%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. 12 | Semiannual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN FOREIGN SECURITIES INVOLVE CERTAIN RISKS INCLUDING CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. SMALLER-COMPANY STOCKS HAVE EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. THE FUND'S INVESTMENTS IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS ALSO INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS. THE FUND MAY INVEST IN LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. CLASS R: Shares are available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. (1.) Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the periods indicated. (3.) Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. Semiannual Report | 13 Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Semiannual Report Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 ----------------- -------------- ---------------------- CLASS Z Actual $1,000 $1,077.60 $ 5.82 Hypothetical (5% return before expenses) $1,000 $1,019.19 $ 5.66 CLASS A Actual $1,000 $1,076.20 $ 7.31 Hypothetical (5% return before expenses) $1,000 $1,017.75 $ 7.10 CLASS B Actual $1,000 $1,072.60 $10.95 Hypothetical (5% return before expenses) $1,000 $1,014.23 $10.64 CLASS C Actual $1,000 $1,072.20 $10.94 Hypothetical (5% return before expenses) $1,000 $1,014.23 $10.64 CLASS R Actual $1,000 $1,075.50 $ 8.39 Hypothetical (5% return before expenses) $1,000 $1,016.71 $ 8.15
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.13%; A: 1.42%; B: 2.13%; C: 2.13%; and R: 1.63%), multiplied by the average account value over the period, multiplied by 181/365 to reflect the one-half year period. Semiannual Report | 15 Mutual Global Discovery Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 22.54 $ 32.45 $ 30.45 $ 26.28 $ 24.26 $ 20.81 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ............ 0.16(c) 0.51 0.69 0.67 0.37 0.41 Net realized and unrealized gains (losses) ......................... 1.59 (9.11) 2.76 5.36 3.43 3.58 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ....... 1.75 (8.60) 3.45 6.03 3.80 3.99 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income ............... -- (0.44) (0.74) (0.63) (0.44) (0.54) Net realized gains .................. -- (0.87) (0.71) (1.23) (1.34) -- ---------- ---------- ---------- ---------- ---------- ---------- Total distributions .................... -- (1.31) (1.45) (1.86) (1.78) (0.54) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ......... $ 24.29 $ 22.54 $ 32.45 $ 30.45 $ 26.28 $ 24.26 ========== ========== ========== ========= ========== ========== Total return(f) ........................ 7.76% (26.55)% 11.32% 23.43% 15.70% 19.39% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 1.13% 1.02% 1.01% 1.05% 1.07% 1.07% Expenses - excluding dividend expense on securities sold short(h) ......... 1.04% 1.02% 1.01% 1.02% 1.04% 1.06% Net investment income .................. 1.37%(c) 1.81% 2.09% 2.28% 1.42% 1.87% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $4,139,808 $3,490,622 $4,720,388 $3,923,802 $3,033,756 $2,578,585 Portfolio turnover rate ................ 13.29% 25.23% 25.12% 22.27% 25.69% 34.34%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.82%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual Global Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------------ CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 22.30 $ 32.09 $ 30.14 $ 26.04 $ 24.07 $ 20.67 ---------- ---------- ---------- ---------- ---------- ---------- Income from investment operations(a): Net investment income(b) ............ 0.12(c) 0.43 0.58 0.55 0.27 0.33 Net realized and unrealized gains (losses) ......................... 1.58 (8.99) 2.73 5.34 3.41 3.54 ---------- ---------- ---------- ---------- ---------- ---------- Total from investment operations ....... 1.70 (8.56) 3.31 5.89 3.68 3.87 ---------- ---------- ---------- ---------- ---------- ---------- Less distributions from: Net investment income ............... -- (0.36) (0.65) (0.56) (0.37) (0.47) Net realized gains .................. -- (0.87) (0.71) (1.23) (1.34) -- ---------- ---------- ---------- ---------- ---------- ---------- Total distributions .................... -- (1.23) (1.36) (1.79) (1.71) (0.47) ---------- ---------- ---------- ---------- ---------- ---------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period ......... $ 24.00 $ 22.30 $ 32.09 $ 30.14 $ 26.04 $ 24.07 ========== ========== ========== ========== ========== ========== Total return(f) ........................ 7.62% (26.73)% 10.96% 23.02% 15.29% 18.98% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 1.42% 1.30% 1.32% 1.36% 1.42% 1.42% Expenses - excluding dividend expense on securities sold short(h) ......... 1.33% 1.30% 1.32% 1.33% 1.39% 1.41% Net investment income .................. 1.08%(c) 1.53% 1.78% 1.97% 1.07% 1.52% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $6,539,763 $5,900,616 $8,913,527 $6,128,353 $3,545,288 $2,106,695 Portfolio turnover rate ................ 13.29% 25.23% 25.12% 22.27% 25.69% 34.34%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.53%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual Global Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------- CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 21.89 $ 31.46 $ 29.55 $ 25.57 $ 23.67 $ 20.35 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income(b) ............ 0.04(c) 0.23 0.36 0.38 0.11 0.18 Net realized and unrealized gains (losses) ......................... 1.55 (8.79) 2.67 5.19 3.33 3.49 -------- -------- -------- -------- -------- -------- Total from investment operations ....... 1.59 (8.56) 3.03 5.57 3.44 3.67 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ............... -- (0.14) (0.41) (0.36) (0.20) (0.35) Net realized gains .................. -- (0.87) (0.71) (1.23) (1.34) -- -------- -------- -------- -------- -------- -------- Total distributions .................... -- (1.01) (1.12) (1.59) (1.54) (0.35) -------- -------- -------- -------- -------- -------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- -------- Net asset value, end of period ......... $ 23.48 $ 21.89 $ 31.46 $ 29.55 $ 25.57 $ 23.67 ======== ======== ======== ======== ======== ======== Total return(f) ........................ 7.26% (27.28)% 10.22% 22.16% 14.59% 18.22% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 2.13% 2.02% 2.01% 2.05% 2.07% 2.07% Expenses - excluding dividend expense on securities sold short(h) ............ 2.04% 2.02% 2.01% 2.02% 2.04% 2.06% Net investment income .................. 0.37%(c) 0.81% 1.09% 1.28% 0.42% 0.87% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $149,145 $160,174 $276,175 $274,181 $225,158 $186,841 Portfolio turnover rate ................ 13.29% 25.23% 25.12% 22.27% 25.69% 34.34%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.82%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual Global Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ---------------------------------------------------------------- CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- ---------- ---------- ---------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 22.16 $ 31.84 $ 29.23 $ 25.90 $ 23.97 $ 20.59 ---------- ---------- ---------- ---------- ---------- -------- Income from investment operations(a): Net investment income(b) ............ 0.04(c) 0.23 0.36 0.36 0.11 0.19 Net realized and unrealized gains (losses) ......................... 1.56 (8.89) 2.70 5.28 3.38 3.53 ---------- ---------- ---------- ---------- ---------- -------- Total from investment operations ....... 1.60 (8.66) 3.06 5.64 3.49 3.72 ---------- ---------- ---------- ---------- ---------- -------- Less distributions from: Net investment income ............... -- (0.15) (0.44) (0.38) (0.22) (0.34) Net realized gains .................. -- (0.87) (0.71) (1.23) (1.34) -- ---------- ---------- ---------- ---------- ---------- -------- Total distributions .................... -- (1.02) (1.15) (1.61) (1.56) (0.34) ---------- ---------- ---------- ---------- ---------- -------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) ---------- ---------- ---------- ---------- ---------- -------- Net asset value, end of period ......... $ 23.76 $ 22.16 $ 31.84 $ 29.93 $ 25.90 $ 23.97 ========== ========== ========== ========== ========== ======== Total return(f) ........................ 7.22% (27.27)% 10.24% 22.17% 14.56% 18.17% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 2.13% 2.01% 2.01% 2.05% 2.07% 2.07% Expenses - excluding dividend expense on securities sold short(h) ............ 2.04% 2.01% 2.01% 2.02% 2.04% 2.06% Net investment income .................. 0.37%(c) 0.82% 1.09% 1.28% 0.42% 0.87% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $2,116,890 $1,978,793 $3,075,593 $2,242,348 $1,435,702 $968,934 Portfolio turnover rate ................ 13.29% 25.23% 25.12% 22.27% 25.69% 34.34%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.82%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 19 Mutual Global Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------- CLASS R (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- ---------- -------- -------- ------- ------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ... $ 22.12 $ 31.85 $ 29.23 $ 25.88 $ 23.94 $ 20.57 -------- -------- -------- -------- ------- ------- Income from investment operations(a): Net investment income(b) .............. 0.10(c) 0.36 0.51 0.50 0.22 0.29 Net realized and unrealized gains (losses) ......................... 1.57 (8.92) 2.72 5.29 3.40 3.54 -------- -------- -------- -------- ------- ------- Total from investment operations ....... 1.67 (8.56) 3.23 5.79 3.62 3.83 -------- -------- -------- -------- ------- ------- Less distributions from: Net investment income ............... -- (0.30) (0.60) (0.51) (0.34) (0.46) Net realized gains .................. -- (0.87) (0.71) (1.23) (1.34) -- -------- -------- -------- -------- ------- ------- Total distributions .................... -- (1.17) (1.31) (1.74) (1.68) (0.46) -------- -------- -------- -------- ------- ------- Redemption fees(d) ..................... -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- ------- ------- Net asset value, end of period ......... $ 23.79 $ 22.12 $ 31.85 $ 29.93 $ 25.88 $ 23.94 ======== ======== ======== ======== ======= ======= Total return(f) ........................ 7.55% (26.92)% 10.76% 22.78% 15.13% 18.84% RATIOS TO AVERAGE NET ASSETS(g) Expenses(h, i) ......................... 1.63% 1.52% 1.51% 1.55% 1.57% 1.57% Expenses - excluding dividend expense on securities sold short(h) ............ 1.54% 1.52% 1.51% 1.52% 1.54% 1.56% Net investment income .................. 0.87%(c) 1.31% 1.59% 1.78% 0.92% 1.37% SUPPLEMENTAL DATA Net assets, end of period (000's) ...... $268,602 $206,858 $275,002 $175,790 $99,501 $46,690 Portfolio turnover rate ................ 13.29% 25.23% 25.12% 22.27% 25.69% 34.34%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.05) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.32%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Benefit of expense reduction rounds to less than 0.01%. (i) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 20 | Semiannual Report Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 68.0% AIRLINES 0.0%(a) (b) ACE Aviation Holdings Inc., A .................................... Canada 1,341,927 $ 6,115,665 (b) Delta Air Lines Inc .............................................. United States 5,719 33,113 (b,c) Northwest Airlines Corp., Contingent Distribution ................ United States 69,160,000 43,571 --------------- 6,192,349 --------------- AUTO COMPONENTS 0.1% (b,c,d) Collins & Aikman Products Co., Contingent Distribution ........... United States 1,967,769 19,678 (b,c,d) Dana Holding Corp., Contingent Distribution ...................... United States 25,003,000 -- (b,e,f) IACNA Investor LLC ............................................... United States 402,771 4,028 (b,e,g) International Automotive Components Group Brazil LLC ............. Brazil 3,819,425 3,420,068 (b,e,f,g) International Automotive Components Group Japan LLC .............. Japan 650,533 1,799,565 (b,e,g) International Automotive Components Group LLC .................... Luxembourg 13,618,870 3,090,121 (b,e,g) International Automotive Components Group NA LLC, A .............. United States 11,533,276 439,418 --------------- 8,772,878 --------------- BEVERAGES 6.1% Brown-Forman Corp., A ............................................ United States 143,200 6,602,952 Brown-Forman Corp., B ............................................ United States 525,362 22,580,059 Carlsberg AS, A .................................................. Denmark 113,300 7,415,341 Carlsberg AS, B .................................................. Denmark 4,089,551 262,264,265 (b) Dr. Pepper Snapple Group Inc. .................................... United States 4,420,669 93,673,976 Fomento Economico Mexicano SAB de CV, ADR ........................ Mexico 3,957,984 127,605,404 Lion Nathan Ltd. ................................................. Australia 2,332,248 21,728,953 (h) Pernod Ricard SA ................................................. France 4,164,829 262,112,121 --------------- 803,983,071 --------------- CAPITAL MARKETS 0.4% Man Group PLC .................................................... United Kingdom 9,099,670 41,547,696 Marfin Investment Group Holdings SA .............................. Greece 3,224,490 13,839,370 --------------- 55,387,066 --------------- CHEMICALS 0.7% (b,c,d) Dow Corning Corp., Contingent Distribution ....................... United States 14,735,153 2,857,538 Sika AG .......................................................... Switzerland 85,406 94,764,593 --------------- 97,622,131 --------------- COMMERCIAL BANKS 3.2% Barclays PLC ..................................................... United Kingdom 24,802,149 115,487,255 BNP Paribas SA ................................................... France 1,644,085 106,652,211 (b,e,f) FE Capital Holdings Ltd. ......................................... Japan 29,212 -- (b) Intesa Sanpaolo SpA .............................................. Italy 25,901,876 83,377,289 (b) Investors Bancorp Inc. ........................................... United States 1,775 16,259 (b,e) NCB Warrant Holdings Ltd., A ..................................... Japan 135,864 -- (b) Royal Bank of Scotland Group PLC ................................. United Kingdom 22,172,940 14,096,741 Societe Generale, A .............................................. France 1,753,702 95,647,090 SunTrust Banks Inc. .............................................. United States 218,700 3,597,615 --------------- 418,874,460 ---------------
Semiannual Report | 21 Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL SERVICES & SUPPLIES 0.1% (b) Comdisco Holding Co. Inc. ........................................ United States 929 $ 6,782 (b,c) Comdisco Holding Co. Inc., Contingent Distribution ............... United States 37,660,000 -- Fursys Inc. ...................................................... South Korea 547,260 9,809,296 --------------- 9,816,078 --------------- COMPUTERS & PERIPHERALS 1.2% (b,e) DecisionOne Corp. ................................................ United States 359,884 593,809 (b,e) DecisionOne Corp., wts., 6/08/17 ................................. United States 197,603 -- (b) Dell Inc. ........................................................ United States 3,355,720 46,074,035 (b) Sun Microsystems Inc. ............................................ United States 11,661,140 107,515,711 --------------- 154,183,555 --------------- CONSTRUCTION MATERIALS 0.4% Ciments Francais SA .............................................. France 399,572 33,805,724 Hanil Cement Co. Ltd. ............................................ South Korea 296,309 17,246,727 --------------- 51,052,451 --------------- CONSUMER FINANCE 0.0%(a) (b,e) Cerberus CG Investor I LLC ....................................... United States 9,005,073 1,710,964 (b,e) Cerberus CG Investor II LLC ...................................... United States 9,005,073 1,710,964 (b,e) Cerberus CG Investor III LLC ..................................... United States 4,502,537 855,482 (b,e) Cerberus FIM Investors Holdco LLC ................................ United States 30,279,560 2,204,352 --------------- 6,481,762 --------------- DIVERSIFIED FINANCIAL SERVICES 1.9% Deutsche Boerse AG ............................................... Germany 2,471,898 191,660,422 (b) Fortis ........................................................... Belgium 12,820,860 43,697,571 Guinness Peat Group PLC .......................................... United Kingdom 33,567,186 14,724,850 (b,c) Marconi Corp., Contingent Distribution ........................... United Kingdom 33,909,700 -- --------------- 250,082,843 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 1.2% (b,e) AboveNet Inc. .................................................... United States 366,651 29,691,398 (b,e) AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 .................................................. United States 464 27,854 (b,e) AboveNet Inc., wts., 9/08/10 ..................................... United States 14,911 857,383 (b,c,d) Global Crossing Holdings Ltd., Contingent Distribution ........... United States 45,658,716 -- (h) Koninklijke KPN NV ............................................... Netherlands 9,499,339 130,559,658 --------------- 161,136,293 --------------- ELECTRIC UTILITIES 1.6% (h) E.ON AG .......................................................... Germany 6,079,540 215,140,330 --------------- ENERGY EQUIPMENT & SERVICES 3.7% (i) Bourbon SA ....................................................... France 1,134,755 44,461,535 (b) BW Offshore Ltd. ................................................. Norway 18,666,535 23,213,835 (b) Compagnie Generale de Geophysique SA ............................. France 2,902,660 52,152,983 (b,f) Dockwise Ltd. .................................................... Norway 12,379,100 13,951,480 (b) Petroleum Geo-Services ASA ....................................... Norway 1,796,568 11,129,232 (b) Pride International Inc. ......................................... United States 2,855,610 71,561,587
22 | Semiannual Report Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) ENERGY EQUIPMENT & SERVICES (CONTINUED) Seadrill Ltd. ................................................ Bermuda 10,795,821 $ 154,060,590 (b) Transocean Ltd. .............................................. United States 1,544,674 114,753,831 --------------- 485,285,073 --------------- FOOD & STAPLES RETAILING 0.7% (h) Carrefour SA ................................................. France 2,249,735 95,989,656 --------------- FOOD PRODUCTS 7.6% Cadbury PLC .................................................. United Kingdom 14,741,669 125,641,967 (b) Cermaq ASA ................................................... Norway 1,259,560 10,034,736 (f) CSM NV ....................................................... Netherlands 4,229,160 62,402,748 (h) Danone ....................................................... France 6,528,096 322,118,915 (f) Farmer Brothers Co. .......................................... United States 904,637 20,698,095 (b) Lighthouse Caledonia ASA ..................................... Norway 1,401,289 60,993 Lotte Confectionary Co. Ltd. ................................. South Korea 52,189 40,938,971 (b,f,i) Marine Harvest ............................................... Norway 178,709,281 120,011,828 Nestle SA .................................................... Switzerland 4,815,172 181,283,318 Nong Shim Co. Ltd. ........................................... South Korea 210,569 37,825,777 (b) Premier Foods PLC ............................................ United Kingdom 89,375,182 54,409,780 Rieber & Son ASA ............................................. Norway 3,605,065 23,817,448 --------------- 999,244,576 --------------- HEALTH CARE PROVIDERS & SERVICES 0.6% (b) Kindred Healthcare Inc. ...................................... United States 1,144,480 14,157,217 Rhoen-Klinikum AG ............................................ Germany 3,163,170 69,833,068 --------------- 83,990,285 --------------- HOTELS, RESTAURANTS & LEISURE 0.0%(a) (b) Trump Entertainment Resorts Inc. ............................. United States 383,593 65,211 --------------- INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 0.0%(a) (b) NRG Energy Inc. .............................................. United States 13,306 345,424 --------------- INDUSTRIAL CONGLOMERATES 3.8% Jardine Matheson Holdings Ltd. ............................... Hong Kong 4,224,266 115,829,374 Jardine Strategic Holdings Ltd. .............................. Hong Kong 9,774,205 144,071,782 Keppel Corp. Ltd. ............................................ Singapore 17,381,344 82,785,444 Koninklijke Philips Electronics NV ........................... Netherlands 272,485 5,016,211 (g) Orkla ASA .................................................... Norway 20,568,718 149,319,767 --------------- 497,022,578 --------------- INSURANCE 3.2% ACE Ltd. ..................................................... United States 689,233 30,484,775 (b) Alleghany Corp. .............................................. United States 78,075 21,158,325 (b) Berkshire Hathaway Inc., A ................................... United States 853 76,770,000 (b) Berkshire Hathaway Inc., B ................................... United States 50,990 147,653,273 E-L Financial Corp. Ltd. ..................................... Canada 177,619 57,352,174 (b,e,f) Imagine Group Holdings Ltd. .................................. Bermuda 4,551,501 41,462,809 Old Republic International Corp. ............................. United States 1,246,689 12,279,887 (b,e) Olympus Re Holdings Ltd. ..................................... United States 47,160 103,063 White Mountains Insurance Group Ltd. ......................... United States 172,815 39,559,082 --------------- 426,823,388 ---------------
Semiannual Report | 23 Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MACHINERY 1.4% (b,e,f,g) Motor Coach Industries International Inc. ........................ United States 5,051 $ 6,568,825 Schindler Holding AG, PC ......................................... Switzerland 2,263,002 140,435,629 Schindler Holding AG, Registered ................................. Switzerland 659,880 40,889,611 --------------- 187,894,065 --------------- MEDIA 2.4% (b) Adelphia Recovery Trust .......................................... United States 45,477,593 1,136,940 (b,c) Adelphia Recovery Trust, Arahova Contingent Value Vehicle, Contingent Distribution ....................................... United States 5,538,790 1,052,370 (b,c) Century Communications Corp., Contingent Distribution ............ United States 15,282,000 -- CJ CGV Co. Ltd. .................................................. South Korea 849,040 14,385,993 Daekyo Co. Ltd. .................................................. South Korea 3,675,700 14,964,609 Eutelsat Communications .......................................... France 8,747,070 225,558,967 (b) JC Decaux SA ..................................................... France 3,609,363 57,282,106 (b,d) TVMAX Holdings Inc. .............................................. United States 118,432 -- Virgin Media Inc. ................................................ United Kingdom 983,718 9,197,763 --------------- 323,578,748 --------------- MULTI-UTILITIES 1.5% (h) GDF Suez ......................................................... France 2,008,006 74,748,036 (b,c) NorthWestern Corp., Contingent Distribution ...................... United States 9,790,000 -- (h) RWE AG ........................................................... Germany 1,471,000 116,159,552 Suez Environnement SA ............................................ France 106,367 1,856,674 --------------- 192,764,262 --------------- MULTILINE RETAIL 0.3% Jelmoli Holding AG ............................................... Switzerland 95,120 34,480,891 --------------- OIL, GAS & CONSUMABLE FUELS 1.8% (h) BP PLC ........................................................... United Kingdom 14,469,794 113,754,034 BP PLC, ADR ...................................................... United Kingdom 180,900 8,625,312 (h) Royal Dutch Shell PLC, A ......................................... United Kingdom 2,783,000 69,481,161 Total SA, B ...................................................... France 510,684 27,562,663 Total SA, B, ADR ................................................. France 417,296 22,629,962 --------------- 242,053,132 --------------- PAPER & FOREST PRODUCTS 0.3% Weyerhaeuser Co. ................................................. United States 1,148,084 34,936,196 --------------- PERSONAL PRODUCTS 0.3% L'Oreal SA ....................................................... France 608,390 45,461,042 --------------- PHARMACEUTICALS 6.7% Schering-Plough Corp. ............................................ United States 17,769,400 446,367,328 Wyeth ............................................................ United States 9,552,554 433,590,426 --------------- 879,957,754 --------------- PROFESSIONAL SERVICES 0.4% Teleperformance .................................................. France 1,872,757 56,921,220 --------------- REAL ESTATE INVESTMENT TRUSTS (REITS) 1.6% Link REIT ........................................................ Hong Kong 91,136,430 194,505,291 Ventas Inc. ...................................................... United States 516,500 15,422,690 --------------- 209,927,981 ---------------
24 | Semiannual Report Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) REAL ESTATE MANAGEMENT & DEVELOPMENT 1.2% (b,d) Canary Wharf Group PLC ........................................... United Kingdom 5,400,183 $ 15,549,085 Great Eagle Holdings Ltd. ........................................ Hong Kong 12,911,868 27,090,282 Swire Pacific Ltd., A ............................................ Hong Kong 9,379,950 94,647,942 Swire Pacific Ltd., B ............................................ Hong Kong 13,605,000 26,051,717 --------------- 163,339,026 --------------- SOFTWARE 0.9% Microsoft Corp. ................................................. United States 4,786,180 113,767,499 --------------- TOBACCO 12.3% Altria Group Inc. ............................................... United States 5,940,908 97,371,482 (h) British American Tobacco PLC ..................................... United Kingdom 16,023,993 441,087,752 (h) Imperial Tobacco Group PLC ....................................... United Kingdom 14,003,829 363,590,150 ITC Ltd .......................................................... India 15,068,790 60,101,593 Japan Tobacco Inc. ............................................... Japan 41,878 131,249,024 KT&G Corp. ....................................................... South Korea 1,759,977 99,402,529 (h) Lorillard Inc. ................................................... United States 4,261,640 288,811,343 Philip Morris International Inc. ................................. United States 2,036,358 88,825,936 Reynolds American Inc. ........................................... United States 1,288,840 49,775,001 --------------- 1,620,214,810 --------------- TRADING COMPANIES & DISTRIBUTORS 0.4% (b,f) Kloeckner & Co. SE .............................................. Germany 2,511,604 53,370,056 --------------- TRANSPORTATION INFRASTRUCTURE 0.0%(a) (b) Groupe Eurotunnel SA ............................................. France 7,050 39,949 (b) Groupe Eurotunnel SA, wts., 12/30/11 ............................. France 200,763 31,819 --------------- 71,768 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $8,429,860,221) ......................................... 8,986,229,908 --------------- PREFERRED STOCKS 0.3% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(a) (b,e) PTV Inc., 10.00%, pfd., A ........................................ United Kingdom 86,280 20,707 --------------- MACHINERY 0.3% (b,e,f,g) Motor Coach Industries International Inc., pfd. .................. United States 36,236 36,236,000 --------------- TOTAL PREFERRED STOCKS (COST $36,290,356) ........................ 36,256,707 ---------------
PRINCIPAL AMOUNT(J) ----------------- CORPORATE BONDS & NOTES 3.9% American General Finance Corp., 5.85%, 6/01/13 ................................................ United States 958,000 550,134 senior note, J, 6.90%, 12/15/17 ............................... United States 13,413,000 7,272,462 (k) BP Capital Markets PLC, FRN, 1.614%, 3/17/11 ..................... United Kingdom 97,708,000 98,917,625 (k) Calpine Corp., Exit Term Loan, FRN, 4.095%, 3/29/14 .............. United States 41,690,924 37,012,285 (e,l) Cerberus CG Investor I LLC, 12.00%, 7/31/14 ...................... United States 7,903,600 1,501,684 (e,l) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ..................... United States 7,903,600 1,501,684 (e,l) Cerberus CG Investor III LLC, 12.00%, 7/31/14 .................... United States 3,951,800 750,842 (e,l) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 .............. United States 89,613,199 6,519,450
Semiannual Report | 25 Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(J) VALUE -------------- ----------------- --------------- CORPORATE BONDS & NOTES (CONTINUED) ConocoPhillips, senior note, 8.75%, 5/25/10 ...................... United States 7,904,000 $ 8,438,524 DecisionOne Corp., (e) senior secured note, 15.00%, 11/30/13 ............................ United States 472,649 527,712 (d) Term Loan B, 15.00%, 8/29/13 ..................................... United States 82,993 92,662 Groupe Eurotunnel SA, cvt., sub. bond, NRS I, T2, 3.00%, 7/28/09 ............................................ France 9,600 EUR 10,772 T2, 3.00%, 7/28/09 ............................................ France 11,935 GBP 20,619 T3, 3.00%, 7/28/10 ............................................ France 7,220,400 EUR 8,101,867 T3, 3.00%, 7/28/10 ............................................ France 4,866,820 GBP 8,408,004 (d,g,k) International Automotive Components Group NA Inc., Revolver, FRN, 5.75%, 1/18/14 ........................................... United States 2,287,131 2,287,131 (e,g,l) International Automotive Components Group NA LLC, 9.00%, 4/01/17 ....................................................... United States 3,472,200 1,575,451 (k) JP Morgan Chase & Co., senior note, C, FRN, 0.734%, 12/21/11 ...................................................... United States 30,489,000 29,538,566 (e,g,k,m) Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ............ United States 47,818,255 45,884,154 (e,g,k,m) Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ................................................. United States 7,584,231 13,212,342 (k,n) Roche Holdings Inc., 144A, FRN, 1.661%, 2/25/10 .................. Switzerland 91,205,000 91,276,140 Seadrill Ltd., cvt., senior note, 3.625%, 11/08/12 ............... Bermuda 14,200,000 11,161,200 Telecom Italia Capital, 4.875%, 10/01/10 .............................................. Italy 22,726,000 22,980,238 senior note, 4.00%, 1/15/10 ................................... Italy 42,709,000 42,921,093 (d,o) TVMAX Holdings Inc., PIK, 11.50%, 9/30/09 ............................................... United States 541,805 152,142 14.00%, 9/30/09 ............................................... United States 900,455 243,223 Vodafone Group PLC, senior note, 7.75%, 2/15/10 .................. United Kingdom 70,997,000 73,412,034 --------------- TOTAL CORPORATE BONDS & NOTES (COST $655,770,214) ........................................... 514,270,040 --------------- CORPORATE BONDS & NOTES IN REORGANIZATION 0.0%(a) (k,l) Charter Communications Operating LLC, Term Loan B, FRN, 6.25%, 3/06/14 ................................................ United States 4,351,337 3,946,119 (d,l) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 .......... United States 40,000 200 (l) Trump Entertainment Resorts Inc., 8.50%, 6/01/15 ................. United States 17,141,134 2,206,921 --------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $20,073,146) ............................................ 6,153,240 --------------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $9,141,993,937) ......................................... 9,542,909,895 --------------- SHORT TERM INVESTMENTS 31.4% U.S. GOVERNMENT AND AGENCY SECURITIES 31.3% (p) FHLB, 7/01/09 .................................................... United States 5,300,000 5,300,000 (p) U.S. Treasury Bills, 7/02/09 ....................................................... United States 215,000,000 214,999,785 7/09/09 ....................................................... United States 300,000,000 299,994,300 7/16/09 ....................................................... United States 300,000,000 299,988,000 7/23/09 ....................................................... United States 300,000,000 299,979,900 (q) 7/30/09 ....................................................... United States 300,000,000 299,963,400 8/06/09 ....................................................... United States 300,000,000 299,956,500
26 | Semiannual Report Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(J) VALUE -------------- ----------------- --------------- SHORT TERM INVESTMENTS (CONTINUED) U.S. GOVERNMENT AND AGENCY SECURITIES (CONTINUED) (p) U.S. Treasury Bills, (continued) 8/13/09 ....................................................... United States 300,000,000 $ 299,948,100 (q) 8/20/09 ....................................................... United States 209,000,000 208,957,364 8/27/09 ....................................................... United States 200,000,000 199,956,600 9/03/09 ....................................................... United States 270,000,000 269,935,200 (q) 9/17/09 - 12/24/09 ............................................ United States 1,136,000,000 1,134,973,386 (q) 10/29/09 ...................................................... United States 150,000,000 149,908,950 12/17/09 ...................................................... United States 150,000,000 149,776,800 --------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $4,132,766,557) ......................................... 4,133,638,285 --------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $13,274,760,494) ........................................ 13,676,548,180 ---------------
SHARES ----------------- (r) INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.1% MONEY MARKET FUNDS (COST $19,048,417) 0.1% (s) Bank of New York Institutional Cash Reserve Fund, 0.12% .......... United States 19,048,417 18,857,933 --------------- TOTAL INVESTMENTS (COST $13,293,808,911) 103.6% .................. 13,695,406,113 OPTIONS WRITTEN (1.0)% ........................................... (137,746,482) SECURITIES SOLD SHORT (3.2)% ..................................... (427,660,167) OTHER ASSETS, LESS LIABILITIES 0.6% .............................. 84,209,316 --------------- NET ASSETS 100.0% ................................................ $13,214,208,780 ===============
CONTRACTS ----------------- (t) OPTIONS WRITTEN 1.0% CALL OPTIONS 1.0% BEVERAGES 0.1% Pernod Ricard SA, Sep. 37.73 Calls, 9/18/09 ...................... France 1,056,000 $ 11,590,318 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(a) Koninklijke KPN NV, Sep. 10 Calls, 9/18/09 ....................... Netherlands 2,073,000 726,897 --------------- ELECTRIC UTILITIES 0.2% E.ON AG, Sep. 19 Calls, 9/18/09 .................................. Germany 3,583,000 32,163,303 --------------- FOOD & STAPLES RETAILING 0.1% Carrefour SA, Sep. 22 Calls, 9/18/09 ............................. France 1,560,000 18,882,924 --------------- FOOD PRODUCTS 0.1% Danone, Sep. 32.08 Calls, 9/18/09 ................................ France 1,231,000 6,871,871 --------------- MULTI-UTILITIES 0.2% GDF Suez, Sep. 23.30 Calls, 9/18/09 .............................. France 1,435,000 8,250,990 RWE AG, Sep. 48 Calls, 9/18/09 ................................... Germany 1,471,000 18,053,216 --------------- 26,304,206 --------------- OIL, GAS & CONSUMABLE FUELS 0.1% BP PLC, Sep. 4.40 Calls, 9/18/09 ................................. United Kingdom 9,205,000 7,080,497 Royal Dutch Shell PLC, Sep. 16 Calls, 9/18/09 .................... United Kingdom 2,783,000 8,002,044 --------------- 15,082,541 ---------------
Semiannual Report | 27 Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY CONTRACTS VALUE -------------- ----------------- --------------- (t) OPTIONS WRITTEN (CONTINUED) CALL OPTIONS (CONTINUED) TOBACCO 0.2% British American Tobacco PLC, Sep. 15 Calls, 9/18/09 ............. United Kingdom 3,850,000 $ 11,750,679 Imperial Tobacco Group PLC, Sep. 16 Calls, 9/18/09 ............... United Kingdom 1,965,000 2,101,523 Lorillard Inc., Sep. 60 Calls, 9/19/09 ........................... United States 14,106 12,272,220 --------------- 26,124,422 --------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $74,815,661) ............................... $ 137,746,482 ---------------
SHARES ----------------- (u) SECURITIES SOLD SHORT 3.2% PHARMACEUTICALS 3.2% Merck & Co. Inc. ................................................. United States 10,247,612 $ 286,523,232 Pfizer Inc. ...................................................... United States 9,409,129 141,136,935 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $379,732,850) ....................................... $ 427,660,167 ---------------
(a) Rounds to less than 0.1% of net assets. (b) Non-income producing. (c) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (d) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the aggregate value of these securities was $21,201,659, representing 0.16% of net assets. (e) See Note 10 regarding restricted securities. (f) See Note 13 regarding holdings of 5% voting securities. (g) See Note 14 regarding other considerations. (h) A portion or all of the security is held in connection with written option contracts open at period end. (i) A portion or all of the security is on loan at June 30, 2009. See Note 1(g). (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) The coupon rate shown represents the rate at period end. (l) See Note 8 regarding credit risk and defaulted securities. (m) See Note 1(f) regarding special purpose entities. (n) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. This security has been deemed liquid under guidelines approved by the Fund's Board of Trustees. At June 30, 2009, the value of this security was $91,276,140, representing 0.69% of net assets. (o) Income may be received in additional securities and/or cash. (p) The security is traded on a discount basis with no stated coupon rate. (q) Security or a portion of the security has been segregated as collateral for securities sold short, open forward contracts, and open option contracts. At June 30, 2009, the value of securities and/or cash pledged amounted to $702,679,916. (r) See Note 1(g) regarding securities on loan. (s) The rate shown is the annualized seven-day yield at period end. (t) See Note 1(c) regarding written options. (u) See Note 1(e) regarding securities sold short. 28 | Semiannual Report Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED) At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(c).
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- --------------- --------------- ---------- ------------ ------------- South Korean Won ........ BANT Sell 289,393,000,470 $ 218,284,000 7/08/09 $ -- $ (8,840,537) South Korean Won ........ BBU Sell 40,942,500,000 30,900,000 7/08/09 -- (1,232,935) South Korean Won ........ BANT Buy 49,249,000,000 39,278,960 7/08/09 -- (626,828) British Pound ........... SSBT Sell 237,471,787 346,612,299 7/13/09 -- (44,105,902) British Pound ........... BANT Sell 39,251,634 59,497,488 7/13/09 -- (5,098,086) British Pound ........... HSBC Sell 14,670,000 21,997,533 7/13/09 -- (2,139,381) British Pound ........... BBU Sell 3,950,000 5,974,178 7/13/09 -- (524,855) British Pound ........... DBFX Sell 3,490,000 5,605,115 7/13/09 -- (137,069) British Pound ........... SSBT Buy 5,520,000 7,833,874 7/13/09 1,248,319 -- British Pound ........... BANT Buy 2,010,000 2,894,099 7/13/09 413,004 -- British Pound ........... HSBC Buy 7,000,000 10,003,000 7/13/09 1,514,273 -- Norwegian Krone ......... BANT Sell 719,034,961 102,310,040 7/13/09 -- (9,424,276) Norwegian Krone ......... HAND Sell 406,000,000 57,472,891 7/13/09 -- (5,617,410) Euro .................... SSBT Sell 71,813,293 93,996,442 7/27/09 -- (6,730,568) Euro .................... DBFX Sell 32,820,000 44,962,967 7/27/09 -- (1,071,135) Euro .................... HSBC Sell 17,290,000 23,619,544 7/27/09 -- (631,816) Euro .................... BANT Sell 3,680,000 5,076,376 7/27/09 -- (85,278) Swiss Franc ............. SSBT Sell 186,321,615 160,799,875 8/10/09 -- (10,718,632) Swiss Franc ............. HSBC Sell 116,428,984 100,110,906 8/10/09 -- (7,067,885) Swiss Franc ............. BANT Sell 67,181,169 59,415,855 8/10/09 -- (2,575,909) Swiss Franc ............. HAND Sell 4,807,987 4,320,000 8/10/09 -- (105,996) Swiss Franc ............. BBU Sell 4,220,832 3,810,000 8/10/09 -- (75,490) Swiss Franc ............. DBFX Sell 9,364,835 8,660,000 8/10/09 39,194 -- British Pound ........... BBU Sell 123,945,388 186,618,993 8/12/09 -- (17,302,237) British Pound ........... DBFX Sell 43,881,798 71,430,790 8/12/09 -- (765,766) Euro .................... BANT Sell 145,077,717 189,144,640 8/13/09 -- (14,420,458) Euro .................... BBU Sell 49,000,000 65,425,780 8/13/09 -- (3,300,292) Euro .................... SSBT Sell 61,277,653 84,650,500 8/13/09 -- (1,295,875) Norwegian Krone ......... HAND Sell 413,948,240 63,704,202 8/19/09 -- (559,239) Norwegian Krone ......... HAND Buy 15,884,638 2,420,000 8/19/09 46,012 -- Norwegian Krone ......... BBU Sell 40,221,755 6,250,000 8/19/09 5,769 -- Norwegian Krone ......... DBFX Sell 58,026,206 9,190,000 8/19/09 181,715 -- Canadian Dollar ......... SSBT Sell 68,123,152 54,938,026 8/31/09 -- (3,662,162) Euro .................... SSBT Sell 194,608,275 258,128,043 8/31/09 -- (14,809,690) Euro .................... BANT Sell 120,978,810 159,163,522 8/31/09 -- (10,509,028) Euro .................... HSBC Sell 37,510,000 50,539,392 8/31/09 -- (2,068,311) Euro .................... BBU Sell 29,030,000 39,525,246 8/31/09 -- (1,189,273) Euro .................... DBFX Sell 3,440,000 4,921,092 8/31/09 96,499 -- British Pound ........... SSBT Sell 122,000,000 172,063,920 9/10/09 -- (28,644,119) New Zealand Dollar ...... BANT Sell 32,995,253 17,467,105 9/10/09 -- (3,719,396) New Zealand Dollar ...... SSBT Sell 1,550,000 876,981 9/10/09 -- (118,286) New Zealand Dollar ...... HSBC Sell 1,600,000 967,632 9/10/09 -- (59,740) New Zealand Dollar ...... BANT Buy 9,150,000 4,710,202 9/10/09 1,165,082 -- New Zealand Dollar ...... SSBT Buy 4,800,000 2,387,187 9/10/09 694,929 -- British Pound ........... BBU Sell 136,077,833 201,803,427 9/14/09 -- (22,062,495)
Semiannual Report | 29 Mutual Global Discovery Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- --------------- --------------- ---------- ------------ ------------- British Pound ........... BANT Sell 6,350,000 $ 9,138,793 9/14/09 $ -- $ (1,307,792) British Pound ........... SSBT Sell 4,430,000 6,585,084 9/14/09 -- (702,848) Euro .................... SSBT Sell 188,410,928 241,116,829 9/14/09 -- (23,110,580) Euro .................... BANT Sell 128,000,000 163,667,000 9/14/09 -- (15,840,148) Euro .................... BBU Sell 73,000,000 99,348,255 9/14/09 -- (3,026,915) Euro .................... SSBT Buy 10,000,000 13,084,900 9/14/09 939,096 -- Euro .................... BANT Buy 18,440,000 25,421,937 9/14/09 438,311 -- Euro .................... AESX Buy 4,610,000 6,349,169 9/14/09 115,894 -- Euro .................... BBU Buy 23,050,000 31,753,104 9/14/09 572,207 -- Australian Dollar ....... HSBC Sell 6,182,811 4,758,542 9/17/09 -- (190,343) Australian Dollar ....... SSBT Sell 13,584,975 10,809,255 9/17/09 -- (64,517) Australian Dollar ....... BANT Sell 5,720,074 4,521,320 9/17/09 -- (59,398) Australian Dollar ....... SSBT Buy 102,300 81,419 9/17/09 465 -- Singapore Dollar ........ SSBT Sell 64,497,235 42,544,021 9/24/09 -- (1,954,119) Singapore Dollar ........ BANT Sell 23,798,538 15,965,566 9/24/09 -- (453,598) Singapore Dollar ........ HSBC Sell 9,531,104 6,455,384 9/24/09 -- (120,346) Singapore Dollar ........ SSBT Buy 3,650,082 2,490,164 9/24/09 28,113 -- Singapore Dollar ........ BBU Sell 7,131,240 4,960,000 9/24/09 39,992 -- Euro .................... BBU Sell 73,000,000 99,332,560 10/13/09 -- (3,033,967) Japanese Yen ............ SSBT Sell 8,035,300,169 81,343,590 10/20/09 -- (2,168,347) Japanese Yen ............ BBU Sell 367,627,780 3,770,000 10/20/09 -- (50,804) Japanese Yen ............ HSBC Sell 779,312,960 8,080,000 10/20/09 -- (19,503) Japanese Yen ............ BANT Buy 196,634,100 1,985,000 10/20/09 58,644 -- Japanese Yen ............ BANT Sell 191,070,000 2,000,000 10/20/09 14,184 -- Japanese Yen ............ DBFX Sell 371,361,200 3,920,000 10/20/09 60,394 -- Japanese Yen ............ AESX Sell 720,551,137 7,510,000 10/20/09 21,217 -- Danish Krone ............ HAND Sell 1,132,111,372 197,212,982 10/23/09 -- (15,648,980) Danish Krone ............ BANT Sell 220,595,782 39,066,032 10/23/09 -- (2,410,851) Danish Krone ............ SSBT Sell 69,541,706 11,923,106 10/23/09 -- (1,152,271) Danish Krone ............ BBU Sell 97,230,994 17,750,000 10/23/09 -- (531,577) Danish Krone ............ BBU Buy 33,479,370 6,330,000 10/23/09 -- (35,138) Danish Krone ............ HAND Buy 116,417,919 20,435,690 10/23/09 1,453,452 -- Euro .................... BANT Sell 124,054,250 159,781,874 11/13/09 -- (14,171,959) Euro .................... SSBT Sell 115,064,958 155,980,763 11/13/09 -- (5,367,925) Euro .................... HSBC Sell 8,370,000 11,196,491 11/13/09 -- (540,258) Euro .................... BBU Sell 141,500,000 196,628,400 11/30/09 -- (1,785,367) Euro .................... BONY Sell 33,472,215 46,462,782 11/30/09 -- (472,542) ------------ ------------- Unrealized appreciation (depreciation) ...................................................... 9,146,765 (325,516,448) ------------ ------------- Net unrealized appreciation (depreciation) ............................................... $(316,369,683) =============
See Abbreviations on page 51. The accompanying notes are an integral part of these financial statements. 30 | Semiannual Report Mutual Global Discovery Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers ............................................................. $12,742,180,267 Cost - Non-controlled affiliated issuers (Note 13) ...................................... 551,628,644 --------------- Total cost of investments ............................................................... $13,293,808,911 =============== Value - Unaffiliated issuers ............................................................ $13,338,900,679 Value - Non-controlled affiliated issuers (Note 13) ..................................... 356,505,434 --------------- Total value of investments (includes securities loaned in the amount of $18,079,545) .... 13,695,406,113 Cash ....................................................................................... 642,717 Cash on deposit with brokers ............................................................... 416,281,271 Foreign currency, at value (cost $92,678,754) .............................................. 93,067,484 Receivables: Investment securities sold .............................................................. 26,053,976 Capital shares sold ..................................................................... 52,480,788 Dividends and interest .................................................................. 26,578,775 Unrealized appreciation on forward exchange contracts ...................................... 9,146,765 Other assets ............................................................................... 16,491 --------------- Total assets ......................................................................... 14,319,674,380 --------------- Liabilities: Payables: Investment securities purchased ......................................................... 154,757,855 Capital shares redeemed ................................................................. 19,645,114 Affiliates .............................................................................. 16,909,618 Options written, at value (premiums received $74,815,661) .................................. 137,746,482 Securities sold short, at value (proceeds $379,732,850) .................................... 427,660,167 Payable upon return of securities loaned ................................................... 19,048,417 Unrealized depreciation on forward exchange contracts ...................................... 325,516,448 Accrued expenses and other liabilities ..................................................... 4,181,499 --------------- Total liabilities .................................................................... 1,105,465,600 --------------- Net assets, at value .............................................................. $13,214,208,780 =============== Net assets consist of: Paid-in capital ............................................................................ $13,117,979,267 Undistributed net investment income ........................................................ 54,518,965 Net unrealized appreciation (depreciation) ................................................. (25,115,389) Accumulated net realized gain (loss) ....................................................... 66,825,937 --------------- Net assets, at value .............................................................. $13,214,208,780 ===============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 31 Mutual Global Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ..................................................... $4,139,808,142 -------------- Shares outstanding ....................................................... 170,401,189 -------------- Net asset value and maximum offering price per share ..................... $ 24.29 -------------- CLASS A: Net assets, at value ..................................................... $6,539,763,415 -------------- Shares outstanding ....................................................... 272,515,399 -------------- Net asset value per share(a) ............................................. $ 24.00 -------------- Maximum offering price per share (net asset value per share / 94.25%) .... $ 25.46 -------------- CLASS B: Net assets, at value ..................................................... $ 149,145,133 -------------- Shares outstanding ....................................................... 6,353,304 -------------- Net asset value and maximum offering price per share(a) .................. $ 23.48 -------------- CLASS C: Net assets, at value ..................................................... $2,116,890,037 -------------- Shares outstanding ....................................................... 89,079,022 -------------- Net asset value and maximum offering price per share(a) .................. $ 23.76 -------------- CLASS R: Net assets, at value ..................................................... $ 268,602,053 -------------- Shares outstanding ....................................................... 11,291,023 -------------- Net asset value and maximum offering price per share ..................... $ 23.79 --------------
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. 32 | Semiannual Report Mutual Global Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends: (net of foreign taxes of $12,804,595) Unaffiliated issuers ............................................. $ 144,380,031 Non-controlled affiliated issuers (Note 13) ...................... 2,194,600 Interest ............................................................ 29,499,074 Reserve for uncollectible interest (Note 8) ......................... (26,917,139) Income from securities loaned ....................................... 96,342 -------------- Total investment income .................................... 149,252,908 -------------- Expenses: Management fees (Note 3a) ........................................... 45,797,772 Administrative fees (Note 3b) ....................................... 4,565,479 Distribution fees: (Note 3c) Class A .......................................................... 8,595,606 Class B .......................................................... 742,753 Class C .......................................................... 9,771,828 Class R .......................................................... 574,273 Transfer agent fees (Note 3e) ....................................... 9,023,214 Custodian fees (Note 4) ............................................. 916,243 Reports to shareholders ............................................. 586,764 Registration and filing fees ........................................ 225,005 Professional fees ................................................... 367,202 Trustees' fees and expenses ......................................... 245,205 Dividends on securities sold short .................................. 5,493,715 Other ............................................................... 352,797 -------------- Total expenses ............................................. 87,257,856 Expense reductions (Note 4) ................................ (296,896) -------------- Net expenses ............................................ 86,960,960 -------------- Net investment income ................................ 62,291,948 -------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ...................................................... (12,698,522) Written options .................................................. 36,183,622 Foreign currency transactions .................................... 251,701,818 Securities sold short ............................................ (7,918,872) -------------- Net realized gain (loss) ...................................... 267,268,046 -------------- Net change in unrealized appreciation (depreciation) on: Investments ...................................................... 1,010,645,567 Translation of other assets and liabilities denominated in foreign currencies .................................................... (436,188,451) -------------- Net change in unrealized appreciation (depreciation) .... 574,457,116 -------------- Net realized and unrealized gain (loss) ................................ 841,725,162 -------------- Net increase (decrease) in net assets resulting from operations ........ $ 904,017,110 ==============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 33 Mutual Global Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, (UNAUDITED) 2008 --------------- --------------- Increase (decrease) in net assets: Operations: Net investment income ............................................... $ 62,291,948 $ 219,364,149 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ......... 267,268,046 174,342,379 Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ................................ 574,457,116 (4,985,786,756) --------------- --------------- Net increase (decrease) in net assets resulting from operations ............................................ 904,017,110 (4,592,080,228) --------------- --------------- Distributions to shareholders from: Net investment income: Class Z .......................................................... -- (65,871,812) Class A .......................................................... -- (92,982,728) Class B .......................................................... -- (1,003,689) Class C .......................................................... -- (13,077,925) Class R .......................................................... -- (2,751,569) Net realized gains: Class Z .......................................................... -- (127,950,427) Class A .......................................................... -- (222,997,703) Class B .......................................................... -- (6,243,078) Class C .......................................................... -- (75,713,594) Class R .......................................................... -- (7,772,855) --------------- --------------- Total distributions to shareholders .................................... -- (616,365,380) --------------- --------------- Capital share transactions: (Note 2) Class Z .......................................................... 367,507,854 228,990,518 Class A .......................................................... 184,505,701 (333,643,137) Class B .......................................................... (21,020,458) (39,919,592) Class C .......................................................... (925,508) (190,280,863) Class R .......................................................... 43,061,334 19,620,226 --------------- --------------- Total capital share transactions ....................................... 573,128,923 (315,232,848) --------------- --------------- Redemption fees ........................................................ -- 55,764 --------------- --------------- Net increase (decrease) in net assets ......................... 1,477,146,033 (5,523,622,692) Net assets: Beginning of period .................................................... 11,737,062,747 17,260,685,439 --------------- --------------- End of period .......................................................... $13,214,208,780 $11,737,062,747 --------------- --------------- Undistributed net investment income (distributions in excess of net investment income) included in net assets: End of period .......................................................... $ 54,518,965 $ (7,772,983) =============== ===============
The accompanying notes are an integral part of these financial statements. 34 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual Global Discovery Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers five classes of shares: Class Z, Class A, Class B, Class C, and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Effective May 1, 2009, the Mutual Discovery Fund was renamed the Mutual Global Discovery Fund. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. Semiannual Report | 35 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. 36 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. The Fund purchases or writes option contracts in order to manage equity price risk. An option is a contract entitling the holder to purchase or sell a specific amount of shares or units of a particular security, currency or index at a specified price. Options purchased are recorded as an asset while options written are recorded as a liability. Upon exercise of an option, the acquisition cost or sales proceeds of the security is adjusted by any premium paid or received. Upon expiration of an option, any premium paid or received is recorded as a realized loss or gain. Upon closing an option other than through expiration or exercise, the difference between the premium and the cost to close the position is recorded as a realized gain or loss. See Note 12 regarding other derivative information. D. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Semiannual Report | 37 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund incurs a loss if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit with broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. F. SPECIAL PURPOSE ENTITIES At June 30, 2009, the Fund contributed an additional $30,109,218 as a subordinated note holder of certain special purpose entities ("SPEs"). Such contributions, while made at the discretion of the Fund, represent additional capital contributions to the SPE in support of its underlying investments and are subject first to the claims of the senior note holders of the SPE. These contributions are recorded as an addition to the Fund's cost basis in the SPE and are subject to the risk of loss in the event of continued unfavorable market conditions related to the SPE's underlying investments. G. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. 38 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Semiannual Report | 39 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the Fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. L. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 --------------------------- ----------------------------- SHARES AMOUNT SHARES AMOUNT ----------- ------------- ----------- --------------- CLASS Z SHARES: Shares sold ...................................... 26,359,130 $ 610,902,271 28,477,645 $ 775,233,356 Shares issued in reinvestment of distributions ... -- -- 7,473,281 171,960,747 Shares redeemed .................................. (10,826,202) (243,394,417) (26,564,255) (718,203,585) ----------- ------------- ----------- --------------- Net increase (decrease) .......................... 15,532,928 $ 367,507,854 9,386,671 $ 228,990,518 =========== ============= =========== =============== CLASS A SHARES: Shares sold ...................................... 43,457,304 $ 982,185,333 62,541,929 $ 1,746,894,696 Shares issued in reinvestment of distributions ... -- -- 12,976,267 296,273,641 Shares redeemed .................................. (35,593,993) (797,679,632) (88,608,493) (2,376,811,474) ----------- ------------- ----------- --------------- Net increase (decrease) .......................... 7,863,311 $ 184,505,701 (13,090,297) $ (333,643,137) =========== ============= =========== =============== CLASS B SHARES: Shares sold ...................................... 362,170 $ 7,975,116 729,461 $ 19,560,586 Shares issued in reinvestment of distributions ... -- -- 290,356 6,523,655 Shares redeemed .................................. (1,327,072) (28,995,574) (2,480,999) (66,003,833) ----------- ------------- ----------- --------------- Net increase (decrease) .......................... (964,902) $ (21,020,458) (1,461,182) $ (39,919,592) =========== ============= =========== ===============
40 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST (CONTINUED)
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 --------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ----------- ------------- ----------- ------------- CLASS C SHARES: Shares sold ...................................... 9,902,399 $ 222,243,967 16,071,463 $ 441,711,886 Shares issued in reinvestment of distributions ................................. -- -- 3,412,597 77,595,846 Shares redeemed .................................. (10,133,009) (223,169,475) (26,776,661) (709,588,595) ----------- ------------- ----------- ------------- Net increase (decrease) .......................... (230,610) $ (925,508) (7,292,601) $(190,280,863) =========== ============= =========== ============= CLASS R SHARES: Shares sold ...................................... 3,208,147 $ 71,273,136 2,738,385 $ 76,292,952 Shares issued in reinvestment of distributions ................................. -- -- 454,146 10,280,244 Shares redeemed .................................. (1,266,867) (28,211,802) (2,475,951) (66,952,970) ----------- ------------- ----------- ------------- Net increase (decrease) .......................... 1,941,280 $ 43,061,334 716,580 $ 19,620,226 =========== ============= =========== =============
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Investment Management Limited (FTIML) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- -------------------------------------------------- 0.800% Up to and including $4 billion 0.770% Over $4 billion, up to and including $7 billion 0.750% Over $7 billion, up to and including $10 billion 0.730% Over $10 billion, up to and including $13 billion 0.710% Over $13 billion, up to and including $16 billion 0.690% In excess of $16 billion
Under a subadvisory agreement, FTIML, an affiliate of Franklin Mutual, provides subadvisory services to the Fund and receives from Franklin Mutual fees based on the average daily net assets of the Fund. Semiannual Report | 41 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- --------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B, C, and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ........... 0.35% Class B ........... 1.00% Class C ........... 1.00% Class R ........... 0.50%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers ....................... $ 1,901,631 Contingent deferred sales charges retained ........... $ 103,156
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $9,023,214, of which $5,225,176 was retained by Investor Services. 42 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. During the period ended June 30, 2009 the Fund's projected benefit obligation and benefit payments under the plan were as follows: (a) Projected benefit obligation at June 30, 2009 ......... $461,354 (b) Increase in projected benefit obligation .............. $ 20,711 Benefit payments made to retired trustees ............. $ 9,801
(a) The projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is indicated in trustees' fees and expenses in the Statement of Operations. 6. INCOME TAXES For tax purposes, realized capital losses and realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses and realized currency losses of $114,203,906 and $6,353,595, respectively. At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ....... $ 13,330,076,795 ================= Unrealized appreciation ... $ 1,385,778,530 Unrealized depreciation ... (1,020,449,212) ----------------- Net unrealized appreciation (depreciation) ......... $ 365,329,318 =================
Net investment income differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through entity income, and bond discounts and premiums. Semiannual Report | 43 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 6. INCOME TAXES (CONTINUED) Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, defaulted securities, foreign currency transactions, pass-through entity income, and bond discounts and premiums. 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $3,629,242,800 and $910,262,054, respectively. Transactions in options written during the period ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED ---------- ------------ Options outstanding at December 31, 2008 ................................ 73,537 $ 31,331,380 Options written ........................ 30,229,657 79,667,903 Options expired ........................ (77,088) (36,183,622) Options exercised ...................... -- -- Options closed ......................... -- -- ---------- ------------ Options outstanding at June 30, 2009 ... 30,226,106 $ 74,815,661 ========== ============
8. CREDIT RISK AND DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. If it becomes probable that income on debt securities, including those of distressed companies, will not be collected, the Fund discontinues accruing income and recognizes a reserve for uncollectible interest. At June 30, 2009, the aggregate value of distressed company securities and securities for which interest has been discontinued was $18,002,351, representing 0.14% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 44 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 10. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- --------------------------------------- ------------------ ----------- ------------ 366,651 AboveNet Inc. ......................... 10/02/01 - 8/08/08 $19,186,841 $ 29,691,398 464 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 .... 4/17/06 - 9/08/06 -- 27,854 14,911 AboveNet Inc., wts., 9/08/10 .......... 10/02/01 - 9/07/07 1,843,189 857,383 9,005,073 Cerberus CG Investor I LLC ............ 7/26/07 - 6/17/08 8,974,232 1,710,964 7,903,600 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............................ 7/26/07 7,903,600 1,501,684 9,005,073 Cerberus CG Investor II LLC ........... 7/26/07 - 6/17/08 8,974,232 1,710,964 7,903,600 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............................ 7/26/07 7,903,600 1,501,684 4,502,537 Cerberus CG Investor III LLC .......... 7/26/07 - 6/17/08 4,487,116 855,482 3,951,800 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............................ 7/26/07 3,951,800 750,842 30,279,560 Cerberus FIM Investors Holdco LLC ..... 11/20/06 - 6/02/09 30,279,560 2,204,352 89,613,199 Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ................... 11/21/06 89,613,199 6,519,450 359,884 (a) DecisionOne Corp. ..................... 9/28/99 - 7/18/00 273,004 593,809 472,649 (a) DecisionOne Corp., senior secured note, 15.00%, 11/30/13 ............. 6/01/09 472,649 527,712 197,603 (a) DecisionOne Corp., wts., 6/08/17 ...... 7/09/07 -- -- 29,212 FE Capital Holdings Ltd. .............. 8/29/03 - 3/10/08 3,397,430 -- 402,771 IACNA Investor LLC .................... 7/24/08 412,479 4,028 4,551,501 Imagine Group Holdings Ltd. ........... 8/31/04 46,614,197 41,462,809 3,819,425 International Automotive Components Group Brazil LLC ................... 4/13/06 - 12/26/08 2,562,157 3,420,068 650,533 International Automotive Components Group Japan LLC .................... 9/26/06 - 3/27/07 5,647,602 1,799,565 13,618,870 (b) International Automotive Components Group LLC .......................... 1/12/06 - 10/16/06 13,622,397 3,090,121 3,472,200 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ....... 3/30/07 3,524,283 1,575,451 11,533,276 International Automotive Components Group NA LLC, A ................... 3/30/07 - 10/10/07 11,416,643 439,418
Semiannual Report | 45 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 10. RESTRICTED SECURITIES (CONTINUED)
PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------- -------------------------------------------- ------------------ ----------- ------------ 5,051 Motor Coach Industries International Inc. .................................... 4/17/09 $ 5,815,267 $ 6,568,825 36,236 Motor Coach Industries International Inc., pfd. .............................. 4/17/09 36,236,000 36,236,000 135,864 NCB Warrant Holdings Ltd., A ............... 12/16/05 - 3/10/08 1,430,514 -- 47,160 Olympus Re Holdings Ltd. ................... 12/19/01 4,560,452 103,063 47,818,255 Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ......................... 1/22/08 - 2/25/08 66,536,831 45,884,154 7,584,231 Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ......... 2/29/08 18,974,873 13,212,342 86,280 PTV Inc., 10.00%, pfd., A .................. 12/07/01 - 3/06/02 54,356 20,707 ------------ TOTAL RESTRICTED SECURITIES (1.53% of Net Assets) ............................. $202,270,129 ============
(a) The Fund also invests in unrestricted securities of the issuer, valued at $92,662 as of June 30, 2009. (b) The Fund also invests in unrestricted securities of the issuer, valued at $2,287,131 as of June 30, 2009. 11. UNFUNDED CAPITAL COMMITMENTS The Fund may enter into certain capital commitments and may be obligated to perform on such agreements at a future date. Unfunded capital commitments requiring recognition are monitored for impairment and any unrealized deprecation is included in the Statement of Assets and Liabilities and the Statement of Operations. At June 30, 2009, the Fund had aggregate unfunded capital commitments of $4,736,493, for which no depreciation has been recognized. 12. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS ASSET DERIVATIVES LIABILITY DERIVATIVES HEDGING INSTRUMENTS --------------------------------------- ----------------------------------------- UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ---------- -------------------------- ------------ Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $9,146,765 forward exchange contracts $325,516,448 Equity contracts ... Investments, at value 27,854 Options written, at value 137,746,482
46 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 12. OTHER DERIVATIVE INFORMATION (CONTINUED) For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- --------------------------------------------- -------------- -------------- ------------- Foreign exchange contracts ....... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $259,050,732 $(436,689,735) 4,321,212,563 Equity contracts ... Net realized gain (loss) from written options/Net change in unrealized appreciation (depreciation) on investments 36,183,622 (62,577,475) 16,203,321
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(c) regarding derivative financial instruments. 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund for the period ended June 30, 2009, were as shown below.
NUMBER OF NUMBER OF SHARES SHARES HELD AT HELD AT REALIZED BEGINNING GROSS GROSS END OF VALUE AT INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS PERIOD END OF PERIOD INCOME GAIN (LOSS) - -------------- ---------- --------- ---------- ---------- ------------- ---------- ----------- NON-CONTROLLED AFFILIATES CSM NV ....................... 4,036,926 192,234 -- 4,229,160 $62,402,748 $1,986,533 $-- Dockwise Ltd. ................ 12,379,100 -- -- 12,379,100 13,951,480 -- -- Farmer Brothers Co. .......... 904,637 -- -- 904,637 20,698,095 208,067 -- FE Capital Holdings Ltd. ..... 29,212 -- -- 29,212 -- -- -- IACNA Investor LLC ........... 402,771 -- -- 402,771 4,028 -- -- Imagine Group Holdings Ltd. .. 4,551,501 -- -- 4,551,501 41,462,809 -- -- International Automotive Components Group Brazil LLC ....................... 3,819,425 -- -- 3,819,425 --(a) -- -- International Automotive Components Group Japan LLC ... 650,533 -- -- 650,533 1,799,565 -- -- Kloeckner & Co. SE ........... 2,511,604 -- -- 2,511,604 53,370,056 -- --
SEMIANNUAL REPORT | 47 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
NUMBER OF NUMBER OF SHARES SHARES REALIZED HELD AT HELD AT CAPITAL BEGINNING OF GROSS GROSS END OF VALUE AT INVESTMENT GAIN NAME OF ISSUER PERIOD ADDITIONS REDUCTIONS PERIOD END OF PERIOD INCOME (LOSS) - -------------- ------------ --------- ---------- ----------- ------------- ---------- -------- NON-CONTROLLED AFFILIATES (CONTINUED) Marine Harvest ...................... 178,709,281 -- -- 178,709,281 $120,011,828 $ -- $-- Motor Coach Industries International Inc. ............... -- 5,051 -- 5,051 6,568,825 -- -- Motor Coach Industries International Inc., pfd .......... -- 36,236 -- 36,236 36,236,000 -- -- ------------ ---------- --- TOTAL AFFILIATED SECURITIES (2.70% of Net Assets) ......... $356,505,434 $2,194,600 $-- ============ ========== ===
(a) As of June 30, 2009, no longer an affiliate. 14. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Managers, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Franklin Mutual serves as investment manager to certain special purpose entities that issue securities held by the Fund. Franklin Mutual is not compensated for such services and does not invest in or exercise control over such entities. As investment manager, Franklin Mutual is primarily responsible for recommending investments in unaffiliated issuers to be held by the special purpose entities. Securities issued by these special purpose entities are restricted under the Securities Act of 1933 and are deemed to be illiquid. 15. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $36,283 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statements of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 48 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL --------------- ------------ ------------- --------------- ASSETS: Investments in Securities: Equity Investments:(a) Airlines ........................ $ 6,148,778 $ 43,571 $ -- $ 6,192,349 Auto Components ................. -- -- 8,772,878 8,772,878 Chemicals ....................... 94,764,593 -- 2,857,538 97,622,131 Commercial Banks ................ 418,874,460 -- --(b) 418,874,460 Commercial Services & Supplies ..................... 9,816,078 -- --(b) 9,816,078 Computers & Peripherals ......... 153,589,746 -- 593,809 154,183,555 Consumer Finance ................ -- -- 6,481,762 6,481,762 Diversified Financial Services .. 250,082,843 -- --(b) 250,082,843 Diversified Telecommunication Services ..................... 160,278,910 878,090 --(b) 161,157,000 Insurance ....................... 385,257,516 -- 41,565,872 426,823,388 Machinery ....................... 181,325,240 -- 42,804,825 224,130,065 Media ........................... 321,389,438 2,189,310 --(b) 323,578,748 Multi-Utilities ................. 192,764,262 -- --(b) 192,764,262 Real Estate Management & Development .................. 147,789,941 -- 15,549,085 163,339,026 All other Equity Investments(c)..... 6,578,668,070 -- -- 6,578,668,070 Corporate Bonds & Notes ............ -- 440,021,563 74,248,477 514,270,040 Corporate Bonds & Notes in Reorganization .................. -- 6,153,040 200 6,153,240 Short Term Investments ............. 4,128,338,285 24,157,933 -- 4,152,496,218 --------------- ------------ ------------ --------------- Total Investments in Securities ....... $13,029,088,160 $473,443,507 $192,874,446 $13,695,406,113 =============== ============ ============ =============== Forward Exchange Contracts ............ $ -- $ 9,146,765 $ -- $ 9,146,765
Semiannual Report | 49 Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 16. FAIR VALUE MEASUREMENTS (CONTINUED)
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL ------------ ------------ ------- ------------ LIABILITIES: Options Written $126,156,164 $ 11,590,318 $-- $137,746,482 Securities Sold Short 427,660,167 -- -- 427,660,167 Forward Exchange Contracts -- 325,516,448 -- 325,516,448
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN UNREALIZED APPRECIATION NET CHANGE (DEPRECIATION) IN ATTRIBUTABLE NET UNREALIZED NET TRANSFER TO ASSETS BEGINNING REALIZED APPRECIATION PURCHASES IN (OUT) OF ENDING STILL HELD BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) LEVEL 3 BALANCE AT PERIOD END ------------ ------------ -------------- ----------- ------------ ------------ -------------- ASSETS Investments in Securities: Equity Investments:(a) Auto Components ........... $ 7,959,761 $ -- $ 825,545 $ (12,428)$ -- $ 8,772,878 $ 825,545 Chemicals ................. 2,857,538 -- -- -- -- 2,857,538 -- Commercial Banks .......... -- -- -- -- -- --(b) -- Commercial Services & Supplies ............... -- -- -- -- -- --(b) -- Computers & Peripherals ... -- -- 593,809 -- -- 593,809 593,809 Consumer Finance .......... 10,830,419 -- (4,674,114) 325,457 -- 6,481,762 (4,674,114) Diversified Financial Services ............... -- -- -- -- -- --(b) -- Diversified Telecommunication Services ............... 18,393,238 -- 10,989,425 -- (29,382,663) --(b) -- Food Products ............. 32,237 -- (6,261) -- (25,976) -- -- Health Care Providers & Services ............... 14,156,073 -- 674,099 -- (14,830,172) -- -- Insurance ................. 37,387,506 -- 4,178,366 -- -- 41,565,872 4,178,366 Machinery ................. -- -- 753,557 42,051,268 -- 42,804,825 753,557 Media ..................... -- -- -- -- -- --(b) -- Multi-Utilities ........... -- -- -- -- -- --(b) -- Real Estate Management & Development ............ 20,815,938 -- (5,266,853) -- -- 15,549,085 (5,266,853) Corporate Bonds & Notes ... 82,052,763 (131,415) 1,485,955 (9,158,826) -- 74,248,477 1,354,540 Corporate Bonds & Notes in Reorganization ......... 837,315 (24,848,297) 29,826,450 (5,815,268) -- 200 -- ------------ ------------ ------------ ----------- ------------ ------------ ----------- Total ........................ $195,322,788 $(24,979,712) $ 39,379,978 $27,390,203 $(44,238,811)$192,874,446 $(2,235,150) ============ ============ ============ =========== ============ ============ ===========
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. 50 | Semiannual Report Mutual Global Discovery Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 17. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 14, 2009 and determined that no events have occured that require disclosure. ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound SELECTED PORTFOLIO ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PC - Participation Certificate PIK - Payment-In-Kind COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 51 Mutual Global Discovery Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. 52 | Semiannual Report Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counter-party credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and its long-term relationship with the Fund as reasons that shareholders choose to invest, and remain invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, Semiannual Report | 53 Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the 54 | Semiannual Report Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional global multi-cap value funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the best performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the best performing quintile. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quintile and exceeded 8%, as shown in the Lipper Section 15(c) Report. The Board was satisfied with such comparative performance. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's best performing quintile of peer funds for the three-, five- and 10-year periods ended December 31, 2008. The trustees concluded that, while the Fund's losses over the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years. The trustees noted that the Fund's overall expense ratio has declined over such period. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may Semiannual Report | 55 Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the second most expensive quintile of its Lipper expense group and its total expenses were in the middle quintile of such group. The Board was satisfied with such comparative expenses, noting that the Fund's contractual management fee rate was within 10 basis points of its Lipper expense group median. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative relationship of investment management and underwriting expenses; shareholder servicing profitability (losses); economies of scale; and the relative contribution of the Fund to the profitability of the investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. 56 | Semiannual Report Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004, with additional breakpoints being added as deemed appropriate by the Board. The trustees assessed the savings to shareholders resulting from such breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor the appropriateness of the breakpoints. The trustees also considered the effects an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. Semiannual Report | 57 Mutual Global Discovery Fund SHAREHOLDER INFORMATION (CONTINUED) PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. 58 | Semiannual Report This page intentionally left blank. This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds AllocatioN Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL GLOBAL DISCOVERY FUND (FORMERLY, MUTUAL DISCOVERY FUND) INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B, C & R) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 477 S2009 08/09 JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR eDELIVERY Log onto franklintempleton.com and click "My Profile" (GRAPHIC) INTERNATIONAL MUTUAL EUROPEAN FUND (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services.
MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ........................................................ 1 SEMIANNUAL REPORT Mutual European Fund ...................................................... 4 Performance Summary ....................................................... 10 Your Fund's Expenses ...................................................... 13 Financial Highlights and Statement of Investments ......................... 15 Financial Statements ...................................................... 26 Notes to Financial Statements ............................................. 30 Shareholder Information ................................................... 44
Shareholder Letter Dear Mutual European Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In Europe and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. Unemployment rose, and 10-year German government bond yields plummeted to a 40-year low of 2.9%, reflecting great skepticism about the prospects for economic recovery in the region.(1) Furthermore, the de facto nationalization of two of the largest banks in the U.K., The Royal Bank of Scotland and Lloyds Bank, the rescue of UBS by the Swiss government, and the rescue of Fortis by Dutch and Belgian officials were stark reminders of the fragility of Europe's financial system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government support would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. The low of early March for the Morgan Stanley Capital International (MSCI) Europe Index -- down more than 21% from 2008 year-end and more than 54% from its peak in July 2007 -- was followed by a rebound of over 35% to its recent second-quarter high on June 11.(2) (1.) Sources: Deutsche Bundesbank; EcoWin. (2.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The MSCI Europe Index is a market capitalization-weighted index designed to measure equity market performance in the European region. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme, is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our global financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, financial institutions in Europe, like their U.S. counterparts, were able to raise capital in the public markets and avoid a worst-case scenario of widespread government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual European Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities. Consistent with the expectations outlined in our 2008 year-end letter, we added to companies in economically defensive industries, with strong market positions, high barriers to entry, and reasonably predictable earnings and cash flows, including companies in the consumer staples sector and the health care sector. We also anticipated purchases in some economically sensitive industries, and likewise increased our investments in some energy companies where we found good value. On the bankruptcy front, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we like, although we expect more of these as "covenant light," highly leveraged balance sheets eventually reach a tipping point. 2 | Not part of the semiannual report On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. The good news here is that we believe the potential returns in these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow-growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual European Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual European Fund seeks capital appreciation, with income as a secondary goal, by investing at least 80% of its net assets in securities of European companies that the manager believes are available at market prices less than their intrinsic value. The Fund defines European companies as issuers organized under the laws of, or whose principal business operations are located in, or who earn at least 50% of their revenue from, European countries, as defined in the prospectus. We are pleased to bring you Mutual European Fund's semiannual report for the period ended June 30, 2009. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. PERFORMANCE OVERVIEW Mutual European Fund - Class Z delivered a +3.01% cumulative total return for the six months under review. The Fund - Class Z outperformed its benchmark, the Morgan Stanley Capital International (MSCI) Europe Index, which had a +2.84% total return in local currency terms.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 10. ECONOMIC AND MARKET OVERVIEW During the six months under review, global equities hit new bear market lows in March before delivering their biggest quarterly rally in more than a decade. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk appetite, rotating capital back into (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The MSCI Europe Index is a market capitalization-weighted index designed to measure equity market performance in the European region and includes reinvested daily net dividends. The index is unmanaged. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 19. 4 | Semiannual Report cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. In the reporting period's final weeks, equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. For example, initial U.S. jobless claims fell to their lowest levels in six months during May, but unemployment rose again at the end of the period to 9.5%.(2) In Europe, policymakers committed to an easier monetary regime, but the euro-zone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(3) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(4) INVESTMENT STRATEGY We follow a distinctive value investment approach, that combines investments in what we believe are undervalued common stocks with distressed debt investing and risk arbitrage. Our style aims to provide our shareholders with superior risk-adjusted results over time. We employ rigorous, fundamental analysis to find compelling situations. In our opinion, successful investing is as much about assessing risk and containing losses as it is about achieving profits. In choosing investments, we look at the market price of an individual company's securities relative to our evaluation of its intrinsic value based on factors including book value, cash flow generation, long-term earnings potential and earnings multiples. We may invest in bankrupt or distressed GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) France .......................................................... 21.6% U.K ............................................................. 19.0% Germany ......................................................... 16.8% Switzerland ..................................................... 11.8% Netherlands ..................................................... 8.0% Italy ........................................................... 4.4% Sweden .......................................................... 3.5% Denmark ......................................................... 3.5% Spain ........................................................... 2.6% Norway .......................................................... 1.8% U.S. ............................................................ 1.7% Belgium ......................................................... 1.6% Ireland ......................................................... 1.6% Jersey Islands .................................................. 0.6% Short-Term Investments & Other Net Assets ....................... 1.5%
(2.) Source: Bureau of Labor Statistics. (3.) Source: European Communities Eurostat. (4.) Source: People's Bank of China. Semiannual Report | 5 companies if we believe the market overreacted to adverse developments or failed to appreciate positive changes. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Food Products 8.2% Oil, Gas & Consumable Fuels 6.7% Insurance 6.3% Chemicals 5.8% Diversified Financial Services 5.8% Diversified Telecommunication Services 5.6% Commercial Banks 4.9% Machinery 4.9% Multi-Utilities 4.8% Tobacco 4.1%
In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION During the six months under review, several holdings had successful outcomes. Three of the Fund's best performing investments were U.K.-based Anglo American, one of the world's largest diversified mining groups; Schindler Holding, a Swiss maker of elevators, escalators and moving walkways; and Luxembourg's ArcelorMittal, the world's largest steel producer. Anglo American benefited from investors' renewed interest in mining and, more generally, commodity-based companies. Anglo's stock price received a further boost toward the end of June as fellow mining company Xstrata made an unsolicited proposal to merge the two companies. At period-end, the situation was still unfolding and our investment in Anglo represented 2.7% of the Fund's total net assets. Schindler's stock price rose after it released strong full-year 2008 financial results and also provided 2009 guidance that was above consensus estimates. The guidance made at year-end 2008 was also reiterated during the company's first quarter 2009 conference call, illustrating the strength of the company's business model. In particular, while orders for new equipment declined, Schindler continued to expand its stable and profitable services business despite significant economic headwinds. At period-end, the Fund's investment in Schindler represented 3.1% of total net assets. ArcelorMittal's share price also advanced during the period under review. While pricing and volumes throughout the steelmaking industry remained weak due largely to reduced demand globally, producer discipline had a positive effect on the company's service center inventories. This allowed pricing power to begin shifting back toward the steel mills and away from end buyers. ArcelorMittal was also able to successfully access the debt and equity markets to shore up its balance sheet and extend near-term debt maturities. With its balance sheet in check and pricing trends appearing to have stabilized, investors seemed to become more comfortable with ArcelorMittal's prospects for upcoming quarters. At period-end the Fund's investment in ArcelorMittal represented 0.5% of total net assets. 6 | Semiannual Report Although the Fund provided positive results during the first half of 2009, it had some disappointments. Three investments that declined in value were Electricite de France (EDF), the country's main electricity generation and distribution company; GDF Suez, another France-based energy company active in the fields of electricity generation, natural gas and renewable energy; and Vodafone Group, a British mobile telecommunications network company. Our investment in EDF, Europe's and France's largest utility, declined in value during the period as continued uncertainties about the future level of French-regulated electricity tariffs weighed on the stock price. Also, the company's strategy to further its position as the world's leading nuclear power plant operator, highlighted by its recent purchase of British Energy and its acquisition in December 2008 of a 50% stake in the nuclear assets of the U.S.'s Constellation Energy, raised investors' concerns about the company's potentially ongoing involvement in merger and acquisition activity. During the period we reduced our stake in EDF and by period-end the Fund's EDF position represented 0.6% of total net assets. Shares of GDF Suez, France's second-largest utility, also lost value during the period as management postponed its E17 billion target for earnings before interest, taxes, depreciation and amortization (EBITDA) by one year, from 2010 until 2011. Also weighing on Suez was the perceived threat of an increased tax burden on the group's Belgian activities. We believed Suez was unjustifiably undervalued and that the company offers an attractive combination of: (1) strong market positions, and not only within the electricity and gas segments of Europe and abroad, but also in liquid natural gas; (2) strong management; (3) a solid financial profile that includes lower debt levels than its competitors; and (4) most importantly, confidence in the sustainability of its dividend. At period-end, Suez was still one of the Fund's larger holdings, representing 2.4% of total net assets. Following a significant price rise near the end of 2008, telecommunications operator Vodafone Group shares fell during the period. The British pound's appreciation against the U.S. dollar reduced the translated value of the company's stake in U.S. carrier Verizon Wireless, and its appreciation against the euro resulted in earnings headwinds. Competitors' results announced during the period indicated the global economic downturn began to impact international roaming and corporate users, important revenue sources for Vodafone. Also, in Spain, Vodafone lost some market share due to increased competition from France Telecom and the MVNOs (Mobile Virtual Network Operators). At period-end, the Fund's investment in Vodafone represented 2.1% of total net assets. TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Schindler Holding AG, ord. & registered 3.1% MACHINERY, SWITZERLAND Nestle SA 3.1% FOOD PRODUCTS, SWITZERLAND Anglo American PLC 2.7% METALS & MINING, U.K. British American Tobacco PLC 2.7% TOBACCO, U.K. Telefonica SA 2.6% DIVERSIFIED TELECOMMUNICATION SERVICES, SPAIN Linde AG 2.6% CHEMICALS, GERMANY Koninklijke KPN NV 2.5% DIVERSIFIED TELECOMMUNICATION SERVICES, NETHERLANDS E.ON AG 2.5% ELECTRIC UTILITIES, GERMANY GDF Suez 2.4% MULTI-UTILITIES, FRANCE Eutelsat Communications 2.4% MEDIA, FRANCE
Semiannual Report | 7 Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual European Fund. We look forward to serving your future investment needs. (PHOTO OF PHILIPPE BRUGERE-TRELAT) /s/ Philippe Brugere-Trelat Philippe Brugere-Trelat Portfolio Manager (PHOTO OF KATRINA DUDLEY) /s/ Katrina Dudley Katrina Dudley, CFA Assistant Portfolio Manager Mutual European Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. 8 | Semiannual Report PHILIPPE BRUGERE-TRELAT has been lead portfolio manager for Mutual European Fund since 2005. He has been a member of the management team of the Mutual Series Funds since 2004, when he rejoined Franklin Templeton Investments. Previously, he was president and portfolio manager of Eurovest. Between 1984 and 1994, Mr. Brugere-Trelat was employed at Heine Securities Corporation, the Fund's former manager. KATRINA DUDLEY has been assistant portfolio manager for Mutual European Fund since 2007. She follows industrial companies (foreign and domestic) including transportation, manufacturers, machinery, electrical equipment and general industrial, as well as domestic health care companies. Prior to joining Franklin Templeton Investments in 2002, Ms. Dudley was an investment analyst at Federated Investors, Inc., responsible for the technology and health care sectors. From 1995 to 2001, Ms. Dudley was a senior manager in the corporate finance division of Ernst & Young LLP, where she specialized in valuation and litigation consulting. Semiannual Report | 9 Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: MEURX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.52 $17.77 $17.25
CLASS A (SYMBOL: TEMIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.49 $17.38 $16.89
CLASS B (SYMBOL: TEUBX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.41 $16.78 $16.37
CLASS C (SYMBOL: TEURX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.42 $17.18 $16.76
10 | Semiannual Report Performance Summary (CONTINUED) PERFORMANCE(1) CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- -------- Cumulative Total Return(2) +3.01% -19.41% +40.67% +156.41% Average Annual Total Return(3) +3.01% -19.41% +7.06% +9.87% Value of $10,000 Investment(4) $10,301 $ 8,059 $14,067 $ 25,641 Total Annual Operating Expenses(5) 1.09%
CLASS A 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- -------- Cumulative Total Return(2) +2.90% -19.63% +38.57% +148.15% Average Annual Total Return(3) -3.01% -24.25% +5.49% +8.87% Value of $10,000 Investment(4) $9,699 $ 7,575 $13,061 $ 23,395 Total Annual Operating Expenses(5) 1.38%
CLASS B 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- -------- Cumulative Total Return(2) +2.50% -20.17% +33.99% +135.31% Average Annual Total Return(3) -1.50% -23.27% +5.71% +8.93% Value of $10,000 Investment(4) $9,850 $ 7,673 $13,202 $ 23,531 Total Annual Operating Expenses(5) 2.09%
CLASS C 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- -------- Cumulative Total Return(2) +2.51% -20.21% +33.88% +132.50% Average Annual Total Return(3) +1.51% -20.99% +6.01% +8.80% Value of $10,000 Investment(4) $10,151 $ 7,901 $13,388 $ 23,250 Total Annual Operating Expenses(5) 2.08%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. Semiannual Report | 11 Performance Summary (Continued) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. BECAUSE THE FUND INVESTS IN ISSUERS LOCATED IN EUROPE, IT MAY EXPERIENCE GREATER VOLATILITY THAN A MORE GEOGRAPHICALLY DIVERSIFIED FUND. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. IN ADDITION, THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS CARRY AN INCREASED RISK OF PRICE FLUCTUATION, ESPECIALLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE CERTAIN RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. (1.) Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the periods indicated. (3.) Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. 12 | Semiannual Report Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. Semiannual Report | 13 Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 ----------------- -------------- ---------------------- CLASS Z Actual $1,000 $1,030.10 $ 5.69 Hypothetical (5% return before expenses) $1,000 $1,019.19 $ 5.66 CLASS A Actual $1,000 $1,029.00 $ 7.14 Hypothetical (5% return before expenses) $1,000 $1,017.75 $ 7.10 CLASS B Actual $1,000 $1,025.70 $10.70 Hypothetical (5% return before expenses) $1,000 $1,014.23 $10.64 CLASS C Actual $1,000 $1,025.10 $10.70 Hypothetical (5% return before expenses) $1,000 $1,014.23 $10.64
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.13%; A: 1.42%; B: 2.13%; and C: 2.13%), multiplied by the average account value over the period, multiplied by 181/365 to reflect the one-half year period. 14 | Semiannual Report Mutual European Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ---------------------------------------------------------------- CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ------------- -------- ---------- ---------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 17.25 $ 26.32 $ 24.59 $ 21.30 $ 19.75 $ 16.79 -------- -------- ---------- ---------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.36 0.48 0.46 0.62 0.42 0.37 Net realized and unrealized gains (losses) ........................... 0.16 (8.90) 3.74 5.08 3.11 3.21 -------- -------- ---------- ---------- -------- -------- Total from investment operations ......... 0.52 (8.42) 4.20 5.70 3.53 3.58 -------- -------- ---------- ---------- -------- -------- Less distributions from: Net investment income ................. -- (0.03) (0.68) (0.66) (0.55) (0.60) Net realized gains .................... -- (0.62) (1.79) (1.75) (1.43) (0.02) -------- -------- ---------- ---------- -------- -------- Total distributions ...................... -- (0.65) (2.47) (2.41) (1.98) (0.62) -------- -------- ---------- ---------- -------- -------- Redemption fees(c) ....................... -- --(d) --(d) --(d) --(d) --(d) -------- -------- ---------- ---------- -------- -------- Net asset value, end of period ........... $ 17.77 $ 17.25 $ 26.32 $ 24.59 $ 21.30 $ 19.75 ======== ======== ========== ========== ======== ======== Total return(e) .......................... 3.01% (32.47)% 17.15% 27.30% 18.03% 21.58% RATIOS TO AVERAGE NET ASSETS(f) Expenses before expense reduction(g) ..... 1.14% 1.09% 1.04% 1.05% 1.05% 1.07% Expenses net of expense reduction(g) ..... 1.13% 1.09% 1.04% 1.05% 1.05% 1.07% Expenses - excluding dividend expense on securities sold short: Expenses before expense reduction ..... 1.14% 1.09% 1.04% 1.04% 1.04% 1.07% Expenses net of expense reduction ..... 1.13% 1.09% 1.04% 1.04% 1.04% 1.07% Net investment income .................... 4.32% 2.22% 1.65% 2.64% 1.99% 2.10% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $828,686 $800,264 $1,250,521 $1,034,000 $788,228 $650,547 Portfolio turnover rate .................. 14.31% 42.15% 39.60% 37.65% 29.84% 33.11%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Effective September 1, 2008, the redemption fee was eliminated. (d) Amount rounds to less than $0.01 per share. (e) Total return is not annualized for periods less than one year. (f) Ratios are annualized for periods less than one year. (g) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 15 Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------------- CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ------------- -------- ---------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 16.89 $ 25.86 $ 24.19 $ 20.99 $ 19.50 $ 16.59 -------- -------- ---------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.33 0.42 0.36 0.56 0.34 0.31 Net realized and unrealized gains (losses) ........................... 0.16 (8.75) 3.70 4.98 3.07 3.16 -------- -------- ---------- -------- -------- -------- Total from investment operations ......... 0.49 (8.33) 4.06 5.54 3.41 3.47 -------- -------- ---------- -------- -------- -------- Less distributions from: Net investment income ................. -- (0.02) (0.60) (0.59) (0.49) (0.54) Net realized gains .................... -- (0.62) (1.79) (1.75) (1.43) (0.02) -------- -------- ---------- -------- -------- -------- Total distributions ...................... -- (0.64) (2.39) (2.34) (1.92) (0.56) -------- -------- ---------- -------- -------- -------- Redemption fees(c) ....................... -- --(d) --(d) --(d) --(d) --(d) -------- -------- ---------- -------- -------- -------- Net asset value, end of period ........... $ 17.38 $ 16.89 $ 25.86 $ 24.19 $ 20.99 $ 19.50 ======== ======== ========== ======== ======== ======== Total return(e) .......................... 2.90% (32.68)% 16.86% 26.96% 17.56% 21.23% RATIOS TO AVERAGE NET ASSETS(f) Expenses before expense reduction(g) ..... 1.43% 1.38% 1.34% 1.34% 1.38% 1.42% Expenses net of expense reduction(g) ..... 1.42% 1.38% 1.34% 1.34% 1.38% 1.42% Expenses - excluding dividend expense on securities sold short: Expenses before expense reduction ..... 1.43% 1.38% 1.34% 1.33% 1.37% 1.42% Expenses net of expense reduction ..... 1.42% 1.38% 1.34% 1.33% 1.37% 1.42% Net investment income .................... 4.03% 1.93% 1.35% 2.35% 1.66% 1.75% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $665,894 $688,842 $1,333,176 $964,717 $707,995 $545,120 Portfolio turnover rate .................. 14.31% 42.15% 39.60% 37.65% 29.84% 33.11%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Effective September 1, 2008, the redemption fee was eliminated. (d) Amount rounds to less than $0.01 per share. (e) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (f) Ratios are annualized for periods less than one year. (g) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------- CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ------------- ------- ------- ------- ------- ------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 16.37 $ 25.24 $ 23.65 $ 20.58 $ 19.14 $ 16.31 ------- ------- ------- ------- ------- ------- Income from investment operations(a): Net investment income(b) .............. 0.25 0.27 0.18 0.38 0.21 0.19 Net realized and unrealized gains (losses) ........................... 0.16 (8.51) 3.60 4.87 3.01 3.10 ------- ------- ------- ------- ------- ------- Total from investment operations ......... 0.41 (8.24) 3.78 5.25 3.22 3.29 ------- ------- ------- ------- ------- ------- Less distributions from: Net investment income ................. -- (0.01) (0.40) (0.43) (0.35) (0.44) Net realized gains .................... -- (0.62) (1.79) (1.75) (1.43) (0.02) ------- ------- ------- ------- ------- ------- Total distributions ...................... -- (0.63) (2.19) (2.18) (1.78) (0.46) ------- ------- ------- ------- ------- ------- Redemption fees(c) ....................... -- --(d) --(d) --(d) --(d) --(d) ------- ------- ------- ------- ------- ------- Net asset value, end of period ........... $ 16.78 $ 16.37 $ 25.24 $ 23.65 $ 20.58 $ 19.14 ======= ======= ======= ======= ======= ======= Total return(e) .......................... 2.50% (33.15)% 16.05% 26.01% 16.87% 20.41% RATIOS TO AVERAGE NET ASSETS(f) Expenses before expense reduction(g) ..... 2.14% 2.09% 2.04% 2.05% 2.05% 2.07% Expenses net of expense reduction(g) ..... 2.13% 2.09% 2.04% 2.05% 2.05% 2.07% Expenses - excluding dividend expense on securities sold short: Expenses before expense reduction ..... 2.14% 2.09% 2.04% 2.04% 2.04% 2.07% Expenses net of expense reduction ..... 2.13% 2.09% 2.04% 2.04% 2.04% 2.07% Net investment income .................... 3.32% 1.22% 0.65% 1.64% 0.99% 1.10% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $24,055 $30,017 $65,317 $63,219 $55,303 $50,216 Portfolio turnover rate .................. 14.31% 42.15% 39.60% 37.65% 29.84% 33.11%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Effective September 1, 2008, the redemption fee was eliminated. (d) Amount rounds to less than $0.01 per share. (e) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (f) Ratios are annualized for periods less than one year. (g) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ------------------------------------------------------------ CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ------------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ..... $ 16.76 $ 25.82 $ 24.17 $ 20.98 $ 19.50 $ 16.60 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .............. 0.26 0.28 0.17 0.38 0.21 0.20 Net realized and unrealized gains (losses) ........................... 0.16 (8.71) 3.69 4.99 3.05 3.15 -------- -------- -------- -------- -------- -------- Total from investment operations ......... 0.42 (8.43) 3.86 5.37 3.26 3.35 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ................. -- (0.01) (0.42) (0.43) (0.35) (0.43) Net realized gains .................... -- (0.62) (1.79) (1.75) (1.43) (0.02) -------- -------- -------- -------- -------- -------- Total distributions ...................... -- (0.63) (2.21) (2.18) (1.78) (0.45) -------- -------- -------- -------- -------- -------- Redemption fees(c) ....................... -- --(d) --(d) --(d) --(d) --(d) -------- -------- -------- -------- -------- -------- Net asset value, end of period ........... $ 17.18 $ 16.76 $ 25.82 $ 24.17 $ 20.98 $ 19.50 ======== ======== ======== ======== ======== ======== Total return(e) .......................... 2.51% (33.14)% 16.03% 26.10% 16.78% 20.43% RATIOS TO AVERAGE NET ASSETS(f) Expenses before expense reduction(g) ..... 2.14% 2.08% 2.04% 2.05% 2.05% 2.07% Expenses net of expense reduction(g) ..... 2.13% 2.08% 2.04% 2.05% 2.05% 2.07% Expenses - excluding dividend expense on securities sold short: Expenses before expense reduction ..... 2.14% 2.08% 2.04% 2.04% 2.04% 2.07% Expenses net of expense reduction ..... 2.13% 2.08% 2.04% 2.04% 2.04% 2.07% Net investment income .................... 3.32% 1.23% 0.65% 1.64% 0.99% 1.10% SUPPLEMENTAL DATA Net assets, end of period (000's) ........ $171,441 $189,244 $384,861 $303,259 $242,894 $205,197 Portfolio turnover rate .................. 14.31% 42.15% 39.60% 37.65% 29.84% 33.11%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Effective September 1, 2008, the redemption fee was eliminated. (d) Amount rounds to less than $0.01 per share. (e) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (f) Ratios are annualized for periods less than one year. (g) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 96.0% AIR FREIGHT & LOGISTICS 1.0% TNT NV ................................................ Netherlands 889,021 $ 17,263,897 --------------- AUTOMOBILES 1.9% Daimler AG ............................................ Germany 894,510 32,269,336 --------------- BEVERAGES 1.6% Carlsberg AS, A ....................................... Denmark 28,600 1,871,833 Carlsberg AS, B ....................................... Denmark 268,482 17,217,840 Pernod Ricard SA ...................................... France 133,612 8,408,827 --------------- 27,498,500 --------------- CAPITAL MARKETS 0.6% Man Group PLC ......................................... United Kingdom 2,163,672 9,878,994 --------------- CHEMICALS 5.8% Akzo Nobel NV ......................................... Netherlands 30,213 1,328,935 BASF SE ............................................... Germany 415,038 16,532,558 Koninklijke DSM NV .................................... Netherlands 530,962 16,629,762 Linde AG .............................................. Germany 532,679 43,655,134 Sika AG ............................................... Switzerland 8,141 9,033,072 Symrise AG ............................................ Germany 773,954 11,419,964 --------------- 98,599,425 --------------- COMMERCIAL BANKS 4.9% Allied Irish Banks PLC ................................ Ireland 5,059,183 12,297,386 Barclays PLC .......................................... United Kingdom 4,769,187 22,206,959 BNP Paribas SA ........................................ France 359,617 23,328,446 (a) Intesa Sanpaolo SpA ................................... Italy 7,553,162 24,313,381 Intesa Sanpaolo SpA, di Risp .......................... Italy 216,893 534,200 --------------- 82,680,372 --------------- CONSTRUCTION & ENGINEERING 0.5% Vinci SA .............................................. France 191,190 8,577,197 --------------- CONSTRUCTION MATERIALS 1.7% CRH PLC ............................................... Ireland 1,179,375 26,963,321 SA des Ciments Vicat .................................. France 31,449 1,808,525 --------------- 28,771,846 --------------- DIVERSIFIED FINANCIAL SERVICES 5.8% Deutsche Boerse AG .................................... Germany 439,484 34,075,714 Groupe Bruxelles Lambert SA ........................... Belgium 368,196 26,906,094 Guinness Peat Group PLC ............................... United Kingdom 11,324,011 4,967,481 Investor AB, B ........................................ Sweden 1,923,934 29,670,331 (a, b) Marconi Corp., Contingent Distribution ................ United Kingdom 28,582,000 -- Oslo Bors VPS Holding ASA ............................. Norway 340,000 3,039,065 --------------- 98,658,685 ---------------
Semiannual Report | 19 Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED TELECOMMUNICATION SERVICES 5.6% (a, c) AboveNet Inc. ......................................... United States 92,335 $ 7,477,288 (a, c) AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ............................ United States 117 7,024 (a, c) AboveNet Inc., wts., 9/08/10 .......................... United States 3,781 217,407 Koninklijke KPN NV .................................... Netherlands 3,093,062 42,511,286 Telefonica SA ......................................... Spain 1,975,274 44,660,774 --------------- 94,873,779 --------------- ELECTRIC UTILITIES 3.1% E.ON AG ............................................... Germany 1,189,790 42,103,813 Electricite de France ................................. France 193,412 9,406,623 --------------- 51,510,436 --------------- ENERGY EQUIPMENT & SERVICES 1.2% (d) Bourbon SA ............................................ France 411,034 16,104,972 (a) Compagnie Generale de Geophysique SA .................. France 236,970 4,257,713 --------------- 20,362,685 --------------- FOOD & STAPLES RETAILING 3.8% Carrefour SA .......................................... France 846,724 36,127,253 Koninklijke Ahold NV .................................. Netherlands 2,433,670 27,935,804 --------------- 64,063,057 --------------- FOOD PRODUCTS 8.2% Cadbury PLC ........................................... United Kingdom 3,506,571 29,886,200 CSM NV ................................................ Netherlands 855,093 12,617,199 Danone ................................................ France 687,120 33,904,886 Nestle SA ............................................. Switzerland 1,370,370 51,592,180 Rieber & Son ASA ...................................... Norway 1,548,350 10,229,426 --------------- 138,229,891 --------------- HEALTH CARE PROVIDERS & SERVICES 1.1% Rhoen-Klinikum AG ..................................... Germany 830,156 18,327,292 --------------- HOTELS, RESTAURANTS & LEISURE 2.3% Accor SA .............................................. France 991,631 39,298,798 --------------- HOUSEHOLD DURABLES 1.1% (a) Berkeley Group Holdings PLC ........................... United Kingdom 1,348,590 17,851,072 --------------- INDUSTRIAL CONGLOMERATES 2.6% Koninklijke Philips Electronics NV .................... Netherlands 526,132 9,685,630 (e) Orkla ASA ............................................. Norway 2,445,205 17,751,104 Siemens AG ............................................ Germany 240,234 16,588,158 --------------- 44,024,892 --------------- INSURANCE 6.3% AXA SA ................................................ France 1,975,081 37,093,631 Brit Insurance Holdings PLC ........................... United Kingdom 2,935,220 9,127,688 (a) Lancashire Holdings Ltd. .............................. United Kingdom 1,475,829 11,309,599 (a, c) Olympus Re Holdings Ltd. .............................. United States 16,080 35,141
20 | Semiannual Report Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INSURANCE (CONTINUED) White Mountains Insurance Group Ltd. .................. United States 57,372 $ 13,133,025 Zurich Financial Services AG .......................... Switzerland 204,810 36,066,459 --------------- 106,765,543 --------------- MACHINERY 4.9% AB SKF, B ............................................. Sweden 2,401,469 29,565,543 Demag Cranes AG ....................................... Germany 65,421 1,479,163 Schindler Holding AG, PC .............................. Switzerland 494,629 30,695,304 Schindler Holding AG, Registered ...................... Switzerland 352,315 21,831,277 --------------- 83,571,287 --------------- MARINE 2.3% A.P. Moller - Maersk AS ............................... Denmark 6,623 39,666,899 --------------- MEDIA 3.3% Eutelsat Communications ............................... France 1,570,236 40,491,365 Vivendi SA ............................................ France 662,589 15,831,433 --------------- 56,322,798 --------------- METALS & MINING 3.7% Anglo American PLC .................................... United Kingdom 1,415,848 41,081,889 Anglo American PLC, ADR ............................... United Kingdom 341,070 4,993,265 ArcelorMittal ......................................... Netherlands 240,828 7,900,800 (a, f) Globe Specialty Metals Inc., 144A ..................... United States 1,430,000 7,865,000 --------------- 61,840,954 --------------- MULTI-UTILITIES 4.8% GDF Suez .............................................. France 1,110,492 41,338,072 RWE AG ................................................ Germany 434,224 34,289,099 Suez Environnement SA ................................. France 309,885 5,409,154 --------------- 81,036,325 --------------- MULTILINE RETAIL 1.0% Jelmoli Holding AG .................................... Switzerland 44,220 16,029,699 --------------- OIL, GAS & CONSUMABLE FUELS 6.7% Eni SpA ............................................... Italy 1,601,915 37,859,357 (a, c, g) Euro Wagon LP ......................................... Jersey Islands 16,127,149 9,892,650 Royal Dutch Shell PLC, A .............................. United Kingdom 1,210,903 30,231,745 Total SA, B ........................................... France 646,123 34,872,584 --------------- 112,856,336 --------------- PHARMACEUTICALS 4.0% GlaxoSmithKline PLC ................................... United Kingdom 1,909,533 33,570,670 Novartis AG ........................................... Switzerland 824,734 33,417,320 --------------- 66,987,990 --------------- REAL ESTATE MANAGEMENT & DEVELOPMENT 0.0%(h) (a, i) Canary Wharf Group PLC ................................ United Kingdom 192,100 553,126 ---------------
Semiannual Report | 21 Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE -------------- ---------------- --------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 4.1% British American Tobacco PLC .......................... United Kingdom 1,640,605 $ 45,160,452 Imperial Tobacco Group PLC ............................ United Kingdom 948,984 24,639,064 --------------- 69,799,516 --------------- TRANSPORTATION INFRASTRUCTURE 0.0%(h) (a) Groupe Eurotunnel SA .................................. France 5,749 32,577 (a) Groupe Eurotunn el SA, wts., 12/30/11 ................. France 444,134 70,392 --------------- 102,969 --------------- WIRELESS TELECOMMUNICATION SERVICES 2.1% Vodafone Group PLC .................................... United Kingdom 18,202,161 35,100,142 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $1,502,373,692) .............................. 1,623,373,738 --------------- PREFERRED STOCKS 2.0% AUTOMOBILES 2.0% Porsche Automobile Holding SE, pfd..................... Germany 498,668 33,432,839 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(h) (a, c) PTV In c., 10.00%, pfd., A ............................ United Kingdom 46,841 11,242 --------------- TOTAL PREFERRED STOCKS (COST $28,066,259) ............. 33,444,081 ---------------
PRINCIPAL AMOUNT(j) ---------------- CORPORATE BONDS & NOTES 0.5% Groupe Eurotunnel SA, cvt., sub. bond, NRS I, T2, 3.00%, 7/28/09 ................................. France 8,000 EUR 8,977 T2, 3.00%, 7/28/09 ................................. France 9,616 GBP 16,613 T3, 3.00%, 7/28/10 ................................. France 3,439,700 EUR 3,859,619 T3, 3.00%, 7/28/10 ................................. France 2,751,256 GBP 4,753,118 --------------- TOTAL CORPORATE BONDS & NOTES (COST $20,759,752) ...... 8,638,327 --------------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $1,551,199,703) .............................. 1,665,456,146 --------------- SHORT TERM INVESTMENTS 6.4% FOREIGN GOVERNMENT SECURITIES 5.0% (k) French Treasury Bills, 9/24/09 ........................ France 10,000,000 EUR 14,008,398 (k) German Treasury Bills, 8/12/09 ............................................ Germany 15,000,000 EUR 21,027,746 9/16/09 - 11/18/09 ................................. Germany 20,000,000 EUR 28,004,487 Government of Germany, 4.00%, 9/11/09 ................. Germany 15,000,000 EUR 21,178,742 --------------- TOTAL FOREIGN GOVERNMENT SECURITIES (COST $79,579,080) 84,219,373 --------------- U.S. GOVERNMENT AND AGENCY SECURITIES 1.0% (k) FHLB, 7/01/09 ......................................... United States 2,100,000 2,100,000 (k, l) U.S. Treasury Bills, 8/27/09 - 10/29/09 ............... United States 14,000,000 13,992,178 --------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $16,087,654) ................................. 16,092,178 ---------------
22 | Semiannual Report Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY SHARES VALUE ------------- --------- -------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $1,646,866,437) 104.9% .......................... $1,765,767,697 -------------- (m)INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.4% MONEY MARKET FUNDS (COST $7,372,865) 0.4% (n)Bank of New York Institutional Cash Reserve Fund, 0.12% .. United States 7,372,865 7,299,136 -------------- TOTAL INVESTMENTS (COST $ 1,654,239,302) 104.9% .......... 1,773,066,833 OTHER ASSETS, LESS LIABILITIES (4.9)% .................... (82,991,758) -------------- NET ASSETS 100.0% ........................................ $1,690,075,075 ==============
(a) Non-income producing. (b) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) See Note 9 regarding restricted securities. (d) A portion or all of the security is on loan at June 30, 2009. See Note 1(e). (e) See Note 12 regarding other considerations. (f) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. This security has been deemed liquid under guidelines approved by the Trust's Board of Trustees. At June 30, 2009, the value of this security was $7,865,000, representing 0.47% of net assets. (g) See Note 11 regarding holdings of 5% voting securities. (h) Rounds to less than 0.1% of net assets. (i) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the value of this security was $553,126, representing 0.03% of net assets. (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) The security is traded on a discount basis with no stated coupon rate. (l) Security or a portion of the security has been segregated as collateral for open forward contracts. At June 30, 2009, the value of securities and/or cash pledged amounted to $5,655,540. (m) See Note 1(e) regarding securities on loan. (n) The rate shown is the annualized seven-day yield at period end. At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(c).
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ----------- --------------- ---------- ------------ ------------- British Pound ....... SSBT Sell 47,007,928 $ 72,647,834 7/13/09 $ -- $ (4,695,471) British Pound ....... BANT Sell 16,907,133 25,981,831 7/13/09 -- (1,837,740) British Pound ....... BBU Sell 10,640,000 16,289,468 7/13/09 -- (1,216,787) British Pound ....... HSBC Sell 1,120,000 1,617,302 7/13/09 -- (225,461) British Pound ....... SSBT Buy 1,392,227 1,948,718 7/13/09 341,948 -- British Pound ....... HAND Buy 2,000,000 2,780,200 7/13/09 510,449 -- British Pound ....... BANT Buy 1,540,000 2,197,906 7/13/09 335,895 -- British Pound ....... HSBC Buy 500,000 714,500 7/13/09 108,162 -- Euro ................ BBU Sell 67,050,000 86,695,650 7/27/09 -- (7,350,253) Euro ................ BANT Sell 63,220,000 81,784,092 7/27/09 -- (6,889,763) Euro ................ SSBT Sell 11,901,904 15,782,996 7/27/09 -- (910,894) Euro ................ HSBC Sell 9,246,619 12,711,260 7/27/09 -- (258,265)
Semiannual Report | 23 Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ----------- --------------- ---------- ------------ ------------- Euro ................ DBFX Sell 6,080,000 $ 8,317,214 7/27/09 $ -- $ (210,737) Swiss Franc ......... BANT Sell 92,892,544 80,427,679 8/10/09 -- (5,084,625) Swiss Franc ......... SSBT Sell 49,075,307 41,983,489 8/10/09 -- (3,192,823) Swiss Franc ......... HSBC Sell 48,673,882 42,169,254 8/10/09 -- (2,637,526) Swiss Franc ......... SSBT Buy 4,435,000 4,155,579 8/10/09 -- (72,936) Swiss Franc ......... BBU Sell 3,234,864 2,920,000 8/10/09 -- (57,856) Swiss Franc ......... HAND Sell 2,403,994 2,160,000 8/10/09 -- (52,998) Swiss Franc ......... BANT Buy 13,171,656 11,640,000 8/10/09 485,178 -- Swiss Franc ......... DBFX Sell 6,873,051 6,350,000 8/10/09 23,008 -- British Pound ....... BBU Sell 28,243,417 42,524,842 8/12/09 -- (3,942,658) British Pound ....... DBFX Sell 3,000,000 4,883,400 8/12/09 -- (52,352) British Pound ....... SSBT Sell 2,412,509 4,005,247 8/12/09 36,065 -- Euro ................ BANT Sell 58,800,000 76,310,150 8/13/09 -- (6,161,136) Euro ................ SSBT Sell 52,049,341 68,208,994 8/13/09 -- (4,794,001) Euro ................ BBU Sell 17,500,000 23,366,350 8/13/09 -- (1,178,676) Euro ................ HSBC Sell 1,103,221 1,500,270 8/13/09 -- (47,078) Norwegian Krone ..... HAND Sell 204,000,658 31,322,861 8/19/09 -- (347,244) Norwegian Krone ..... SSBT Buy 3,800,000 603,184 8/19/09 -- (13,253) Norwegian Krone ..... BANT Buy 11,675,000 1,816,033 8/19/09 -- (3,546) Norwegian Krone ..... HAND Buy 426,654 65,000 8/19/09 1,236 -- Norwegian Krone ..... BBU Sell 4,759,318 740,000 8/19/09 1,139 -- Norwegian Krone ..... DBFX Sell 6,349,622 1,000,000 8/19/09 14,252 -- Euro ................ SSBT Sell 121,787,795 155,138,217 8/31/09 -- (15,668,932) Euro ................ BANT Sell 20,847,134 27,974,936 8/31/09 -- (1,263,129) Euro ................ HSBC Sell 10,370,000 13,981,628 8/31/09 -- (562,278) Euro ................ BBU Sell 18,530,000 25,641,018 8/31/09 -- (347,271) Euro ................ SSBT Buy 21,500,000 27,934,520 8/31/09 2,219,189 -- Euro ................ DBFX Sell 4,560,000 6,523,308 8/31/09 127,917 -- British Pound ....... SSBT Sell 14,200,000 20,027,112 9/10/09 -- (3,333,988) New Zealand Dollar .. BANT Sell 12,245,021 6,482,303 9/10/09 -- (1,380,317) New Zealand Dollar .. SSBT Sell 2,025,000 1,146,663 9/10/09 -- (153,605) New Zealand Dollar .. HSBC Sell 620,000 374,957 9/10/09 -- (23,149) New Zealand Dollar .. SSBT Buy 4,687,060 2,543,412 9/10/09 466,185 -- New Zealand Dollar .. BANT Buy 2,502,600 1,301,729 9/10/09 305,209 -- British Pound ....... BBU Sell 17,685,522 26,227,629 9/14/09 -- (2,867,379) British Pound ....... SSBT Sell 1,362,198 1,998,346 9/14/09 -- (242,648) British Pound ....... BANT Sell 900,000 1,295,262 9/14/09 -- (185,356) Euro ................ BANT Sell 47,890,000 61,278,565 9/14/09 -- (5,882,352) Euro ................ BBU Sell 71,000,000 96,626,385 9/14/09 -- (2,943,986) Euro ................ SSBT Sell 6,610,947 8,470,556 9/14/09 -- (800,634) Euro ................ HSBC Sell 3,550,000 4,575,240 9/14/09 -- (403,279) Euro ................ SSBT Buy 27,909,547 37,548,529 9/14/09 1,619,675 -- Euro ................ AESX Buy 3,180,000 4,379,687 9/14/09 79,944 -- Euro ................ BANT Buy 12,720,000 17,536,174 9/14/09 302,349 -- Euro ................ BBU Buy 35,900,000 49,818,043 9/14/09 528,103 -- Swedish Krona ....... HAND Sell 454,857,631 53,611,127 9/16/09 -- (5,326,483) Swedish Krona ....... SSBT Sell 57,920,422 7,281,079 9/16/09 -- (223,887)
24 | Semiannual Report Mutual European Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ----------- --------------- ---------- ------------ ------------- Swedish Krona ....... BANT Sell 12,300,000 $ 1,534,527 9/16/09 $ -- $ (59,230) Swedish Krona ....... HAND Buy 41,677,590 5,290,351 9/16/09 109,970 -- Swedish Krona ....... BANT Buy 44,200,000 5,550,709 9/16/09 176,451 -- Swedish Krona ....... SSBT Buy 9,684,186 1,231,223 9/16/09 23,593 -- Euro ................ BBU Sell 65,000,000 88,446,800 10/13/09 -- (2,701,478) Euro ................ SSBT Sell 1,480,782 2,018,440 10/13/09 -- (58,034) Danish Krone ........ HAND Sell 150,283,351 26,048,019 10/23/09 -- (2,208,573) Danish Krone ........ BANT Sell 12,901,291 2,307,811 10/23/09 -- (117,917) Danish Krone ........ SSBT Sell 5,857,291 1,002,635 10/23/09 -- (98,666) Danish Krone ........ BBU Sell 7,338,056 1,340,000 10/23/09 -- (39,717) Danish Krone ........ BBU Buy 581,790 110,000 10/23/09 -- (611) Danish Krone ........ HAND Buy 10,660,654 1,833,373 10/23/09 171,068 -- Danish Krone ........ SSBT Buy 63,583,021 10,965,892 10/23/09 989,121 -- Danish Krone ........ BANT Buy 3,800,000 711,810 10/23/09 2,674 -- Euro ................ BANT Sell 54,269,554 69,899,185 11/13/09 -- (6,199,755) Euro ................ HSBC Sell 3,220,000 4,312,906 11/13/09 -- (202,307) Euro ................ BBU Sell 113,500,000 157,719,600 11/30/09 -- (1,432,079) Euro ................ BONY Sell 26,640,619 36,979,843 11/30/09 -- (376,097) ---------- ------------- Unrealized appreciation (depreciation) .............................................. 8,978,780 (106,337,216) ---------- ------------- Net unrealized appreciation(depreciation) ........................................ $ (97,358,436) =============
See Abbreviations on page 43. The accompanying notes are an integral part of these financial statements. Semiannual Report | 25 Mutual European Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers ............................. $1,647,941,058 Cost - Controlled affiliated issuers (Note 11) .......... 6,298,244 -------------- Total cost of investments ............................... $1,654,239,302 -------------- Value - Unaffiliated issuers ............................ $1,763,174,183 Value - Controlled affiliated issuers (Note 11) ......... 9,892,650 -------------- Total value of investments (includes securities loaned in the amount of $6,927,391) ......................... 1,773,066,833 Cash ....................................................... 28,285 Cash on deposit with brokers ............................... 15,773 Foreign currency, at value (cost $16,719,438) .............. 16,630,163 Receivables: Investment securities sold .............................. 8,927,222 Capital shares sold ..................................... 2,376,770 Dividends and interest .................................. 7,519,073 Unrealized appreciation on forward exchange contracts ...... 8,978,780 Other assets ............................................... 2,402 -------------- Total assets ......................................... 1,817,545,301 -------------- Liabilities: Payables: Investment securities purchased ......................... 8,146,886 Capital shares redeemed ................................. 3,019,498 Affiliates .............................................. 2,094,383 Payable upon return of securities loaned ................... 7,372,865 Unrealized depreciation on forward exchange contracts ...... 106,337,216 Accrued expenses and other liabilities ..................... 499,378 -------------- Total liabilities .................................... 127,470,226 -------------- Net assets, at value .............................. $1,690,075,075 -------------- Net assets consist of: Paid-in capital ............................................ $1,721,502,032 Undistributed net investment income ........................ 80,447,396 Net unrealized appreciation (depreciation) ................. 21,533,626 Accumulated net realized gain (loss) ....................... (133,407,979) -------------- Net assets, at value .............................. $1,690,075,075 --------------
The accompanying notes are an integral part of these financial statements. 26 | Semiannual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ......................................... $828,686,153 ------------ Shares outstanding ........................................... 46,623,879 ------------ Net asset value and maximum offering price per share ......... $ 17.77 ------------ CLASS A: Net assets, at value ......................................... $665,893,562 ------------ Shares outstanding ........................................... 38,315,755 ------------ Net asset value per share(a) ................................. $ 17.38 ------------ Maximum offering price per share (net asset value per share / 94.25%) ........................................... $ 18.44 ------------ CLASS B: Net assets, at value ......................................... $ 24,054,507 ------------ Shares outstanding ........................................... 1,433,124 ------------ Net asset value and maximum offering price per share(a) ...... $ 16.78 ------------ CLASS C: Net assets, at value ......................................... $171,440,853 ------------ Shares outstanding ........................................... 9,977,609 ------------ Net asset value and maximum offering price per share(a) ...... $ 17.18 ------------
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. Semiannual Report | 27 Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends (net of foreign taxes of $5,671,661) ............... $ 40,728,323 Interest ..................................................... 2,975,326 Income from securities loaned ................................ 81,813 ------------ Total investment income ................................... 43,785,462 ------------ Expenses: Management fees (Note 3a) .................................... 6,339,891 Administrative fees (Note 3b) ................................ 615,722 Distribution fees: (Note 3c) Class A ................................................... 942,161 Class B ................................................... 125,452 Class C ................................................... 837,038 Transfer agent fees (Note 3e and 3f) ......................... 1,745,618 Custodian fees (Note 4) ...................................... 121,223 Reports to shareholders ...................................... 87,870 Registration and filing fees ................................. 91,745 Professional fees ............................................ 57,097 Trustees' fees and expenses .................................. 35,175 Other ........................................................ 38,174 ------------ Total expenses ......................................... 11,037,166 ------------ Expense reductions (Note 4) ............................ (64,326) ------------ Net expenses ........................................ 10,972,840 ------------ Net investment income ............................ 32,812,622 ------------ Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ............................................... (50,043,223) Written options ........................................... 2,921,249 Foreign currency transactions ............................. 70,642,653 ------------ Net realized gain (loss) ............................ 23,520,679 ------------ Net change in unrealized appreciation (depreciation) on: Investments ............................................... 74,964,862 Translation of other assets and liabilities denominated in foreign currencies ..................................... (89,619,881) ------------ Net change in unrealized appreciation (depreciation) ................................... (14,655,019) ------------ Net realized and unrealized gain (loss) ......................... 8,865,660 ------------ Net increase (decrease) in net assets resulting from operations .................................................. $ 41,678,282 ------------
The accompanying notes are an integral part of these financial statements. 28 | Semiannual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED JUNE 30, 2009 YEAR ENDED (UNAUDITED) DECEMBER 31, 2008 ---------------- ----------------- Increase (decrease) in net assets: Operations: Net investment income ................................................... $ 32,812,622 $ 47,126,249 Net realized gain (loss) from investments, written options, synthetic equity swaps and foreign currency transactions ....................... 23,520,679 (164,934,931) Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ........................................................... (14,655,019) (822,984,577) -------------- --------------- Net increase (decrease) in net assets resulting from operations ... 41,678,282 (940,793,259) -------------- --------------- Distributions to shareholders from: Net investment income: Class Z .............................................................. -- (1,344,248) Class A .............................................................. -- (1,021,671) Class B .............................................................. -- (10,630) Class C .............................................................. -- (71,542) Net realized gains: Class Z .............................................................. -- (28,735,359) Class A .............................................................. -- (28,582,364) Class B .............................................................. -- (1,314,467) Class C .............................................................. -- (8,013,566) -------------- --------------- Total distributions to shareholders ........................................ -- (69,093,847) -------------- --------------- Capital share transactions: (Note 2) Class Z .............................................................. 5,436,775 (21,190,077) Class A .............................................................. (38,684,463) (206,303,695) Class B .............................................................. (6,247,722) (15,249,087) Class C .............................................................. (20,474,838) (72,883,564) -------------- --------------- Total capital share transactions ........................................... (59,970,248) (315,626,423) -------------- --------------- Redemption fees ............................................................ -- 6,214 -------------- --------------- Net increase (decrease) in net assets ............................. (18,291,966) (1,325,507,315) Net assets: Beginning of period ........................................................ 1,708,367,041 3,033,874,356 -------------- --------------- End of period .............................................................. $1,690,075,075 $ 1,708,367,041 -------------- --------------- Undistributed net investment income included in net assets: End of period .............................................................. $ 80,447,396 $ 47,634,774 -------------- ---------------
The accompanying notes are an integral part of these financial statements. Semiannual Report | 29 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual European Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that 30 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, Semiannual Report | 31 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. See Note 10 regarding other derivative information. D. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. E. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. 32 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. G. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. H. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Semiannual Report | 33 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. J. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 -------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ---------- ------------- ----------- ------------- CLASS Z SHARES: Shares sold ......................... 3,270,694 $ 55,242,945 6,362,672 $ 139,583,893 Shares issued in reinvestment of distributions .................... -- -- 1,334,515 28,398,589 Shares redeemed ..................... (3,030,375) (49,806,170) (8,831,021) (189,172,559) ---------- ------------- ----------- ------------- Net increase (decrease) ............. 240,319 $ 5,436,775 (1,133,834) $ (21,190,077) ========== ============= =========== ============= CLASS A SHARES: Shares sold ......................... 4,262,891 $ 69,782,151 11,146,433 $ 237,432,604 Shares issued in reinvestment of distributions .................... -- -- 996,973 20,786,953 Shares redeemed ..................... (6,721,031) (108,466,614) (22,931,814) (464,523,252) ---------- ------------- ----------- ------------- Net increase (decrease) ............. (2,458,140) $ (38,684,463) (10,788,408) $(206,303,695) ========== ============= =========== ============= CLASS B SHARES: Shares sold ......................... 32,367 $ 527,621 49,442 $ 1,083,347 Shares issued in reinvestment of distributions .................... -- -- 58,945 1,194,222 Shares redeemed ..................... (432,660) (6,775,343) (863,163) (17,526,656) ---------- ------------- ----------- ------------- Net increase (decrease) ............. (400,293) $ (6,247,722) (754,776) $ (15,249,087) ========== ============= =========== =============
34 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST (CONTINUED)
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ------------------------- -------------------------- SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------- CLASS C SHARES: Shares sold ...................... 422,611 $ 7,007,633 1,111,026 $ 24,508,416 Shares issued in rein vestment of distributions ................. -- -- 333,804 6,907,799 Shares redeemed .................. (1,735,252) (27,482,471) (5,062,256) (104,299,779) ---------- ------------ ---------- ------------- Net increase (decrease) .......... (1,312,641) $(20,474,838) (3,617,426) $ (72,883,564) ========== ============ ========== =============
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Transfer agent Services)
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ---------- ----------------------------------------------- 0.800% Up to and including $1 billion 0.770% Over $1 billion, up to and including $2 billion 0.750% Over $2 billion, up to and including $5 billion 0.730% In excess of $5 billion
B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ---------- --------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
Semiannual Report | 35 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A .................. 0.35% Class B .................. 1.00% Class C .................. 1.00%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers ......................... $43,274 Contingent deferred sales charges retained ............. $ 7,158
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $1,745,618, of which $1,239,056 was retained by Investor Services. F. SPECIAL SERVICING AGREEMENT Effective May 1, 2009, the Fund, which is an underlying investment of one or more of the Franklin Templeton Fund Allocator Series Funds (Allocator Funds), entered into a Special Servicing Agreement with the Allocator Funds, pursuant to which the Fund pays a portion of eligible Allocator Funds' expenses, which include transfer agency and shareholder service costs, to the extent such payments are less than the amount of the benefits realized or expected to be realized by the Fund from the investment in the Fund by the Allocator Funds. Expenses allocated to the Fund under the Special Servicing Agreement are included in transfer agent fees on the Statement of Operations, and the amount payable to the Allocator Funds is included in the 36 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) F. SPECIAL SERVICING AGREEMENT (CONTINUED) affiliates on the Statements of Assets and Liabilities. For the period ended June 30, 2009, the Fund was allocated expenses of $45,883. The investment manager and administrative manager of the Fund have voluntarily agreed to limit the increase in the Fund's net annual operating expense ratio that results from the implementation of the Special Servicing Agreement at 0.02% through April 30, 2010. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. 5. INDEPENDENT TRUSTEES' RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the Plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. During the period ended June 30, 2009, the Fund's projected benefit obligation and benefit payments under the Plan were as follows: (a) Projected benefit obligation at June 30, 2009 ...... $65,052 (b) Increase in projected benefit obligation ........... $ 2,797 Benefit payments made to retired trustees ........... $ 1,362
(a) The projected benefit obligation is included in accrued expenses and other liabilities on the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is included in trustees' fees and expenses on the Statement of Operations. 6. INCOME TAXES For tax purposes, capital losses may be carried over to offset future capital gains, if any. At December 31, 2008, the Fund had tax basis capital losses of $58,865,131 expiring in 2016. For tax purposes, realized capital losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses of $108,888,665. Semiannual Report | 37 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 6. INCOME TAXES (CONTINUED) At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ........... $1,662,700,617 -------------- Unrealized appreciation ....... $ 257,858,962 Unrealized depreciation ....... (147,492,746) -------------- Net unrealized appreciation (depreciation) ............. $ 110,366,216 ==============
Net investment income differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through entity income, and bond discounts and premiums. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, defaulted securities, foreign currency transactions, synthetic equity swaps, pass-through entity income, and bond discounts and premiums. 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $510,917,636 and $201,295,908, respectively. Transactions in options written during the year ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED --------- ----------- Options outstanding at December 31, 2008 ... 46,768 $ 3,126,687 Options written ............................ 995 498,789 Options expired ............................ (5,807) (2,921,249) Options exercised .......................... (41,956) (704,227) Options closed ............................. -- -- ------ ----------- Options outstan ding at June 30, 2009 ...... -- $ -- ====== ===========
8. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 38 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ---------------- ------------------------------------- ------------------ ------------- ----------- 92,335 AboveNet Inc. ....................... 10/02/01 - 8/08/08 $4,586,047 $ 7,477,288 117 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ..................... 4/17/06 - 9/08/06 -- 7,024 3,781 AboveNet Inc., wts., 9/08/10 ........ 10/02/01 - 9/07/07 392,580 217,407 16,127,149 Euro Wagon LP ....................... 12/08/05 - 1/02/08 6,298,244 9,892,650 16,080 Olympus Re Holdings Ltd. ............ 12/19/01 1,554,963 35,141 46,841 PTV Inc., 10.00%, pfd., A ........... 12/07/01 - 3/06/02 29,510 11,242 ----------- TOTAL RESTRICTED SECURITIES (1.04% of Net Assets) ............. $17,640,752 ===========
10. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
ASSET DERIVATIVES LIABILITY DERIVATIVES ------------------------------------ --------------------------------------- DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS HEDGING INSTRUMENTS UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- ----------------------- ---------- ----------------------- ------------- Foreign exchange contracts ....... Unrealized appreciation Unrealized depreciation on forward exchange on forward exchange contracts $8,978,780 contracts $ 106,337,216 Equity contracts ... Investments, at value 7,024 -- --
Semiannual Report | 39 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 10. OTHER DERIVATIVE INFORMATION (CONTINUED) For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- ------------------------------------- -------------- -------------- -------------- Foreign exchange contracts .......... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $72,239,567 $(89,582,490) 1,795,736,520 Equity contracts ... Net realized gain (loss) from investments/Net change in unrealized appreciation (depreciation) on investments (13,050,854) (1,005,795) 101,995
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted to U.S. dollars. See Note 1(c) regarding derivative financial instruments. 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund for the period ended June 30, 2009, were as shown below.
NUMBER OF SHARES HELD AT NUMBER OF SHARES VALUE AT REALIZED BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME GAIN (LOSS) - -------------- ---------------- --------- ---------- ---------------- ---------- ---------- ----------- CONTROLLED AFFILIATES(a) Euro Wagon LP (0.59% of Net Assets) ....... 16,127,149 -- -- 16,127,149 $9,892,650 $-- $-- ---------- --- ---
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. 12. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. 40 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 13. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $1,137 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statements of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 14. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. Semiannual Report | 41 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 14. FAIR VALUE MEASUREMENTS (CONTINUED) The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL -------------- ------------ ----------- -------------- ASSETS: Investments in Securities: Equity Investments:(a) Diversified Financial Services ... $ 98,658,685 $ -- $ --(b)$ 98,658,685 Insurance ........................ 106,730,402 -- 35,141 106,765,543 Metals & Mining .................. 53,975,954 -- 7,865,000 61,840,954 Oil, Gas & Consumable Fuels ...... 102,963,686 -- 9,892,650 112,856,336 Real Estate Management & Development ................... -- -- 553,126 553,126 All Other Equity Investments(c) .. 1,276,143,175 -- -- 1,276,143,175 Corporate Bonds & Notes ............. -- 8,638,327 -- 8,638,327 Short Term Investments .............. 13,992,178 93,618,509 -- 107,610,687 -------------- ------------ ----------- -------------- Total Investments in Securities ..... $1,652,464,080 $102,256,836 $18,345,917 $1,773,066,833 ============== ============ =========== ============== Forward Exchange Contracts .......... $ -- $ 8,978,780 $ -- $ 8,978,780 LIABILITIES: Forward Exchange Contracts .......... $ -- $106,337,216 $ -- $ 106,337,216
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN UNREALIZED NET CHANGE APPRECIATION IN (DEPRECIATION) NET UNREALIZED NET TRANSFER ATTRIBUTABLE TO BEGINNING REALIZED APPRECIATION PURCHASES IN (OUT) OF ENDING ASSETS STILL HELD BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) LEVEL 3 BALANCE AT PERIOD END ----------- ----------- -------------- --------- ----------- ----------- ----------------- ASSETS: Investment in Securities: Equity Investments:(a) Diversified Telecommunication Services ........ $ 4,632,137 $-- $2,768,887 $-- $(7,401,024) $ -- $ -- Insurance .......... 37,749 -- (2,608) -- -- 35,141 (2,608) Metals & Mining .... -- -- 3,575,000 4,290,000 7,865,000 3,575,000 Oil, Gas & Consumable Fuels ........... 8,492,240 -- 1,400,410 -- -- 9,892,650 1,400,410 Real Estate Management & Development ... 740,483 -- (187,357) -- -- 553,126 (187,357) ----------- --- ---------- --- ----------- ----------- ---------- Total ................. $13,902,609 $-- $7,554,332 $-- $(3,111,024) $18,345,917 $4,785,445 =========== === ========== === =========== =========== ==========
(a) Includes common and preferred stocks as well as other equity investments. 42 | Semiannual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 15. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 17, 2009 and determined that no events have occurred that require disclosure. ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound SELECTED PORTFOLIO ADR - American Depository Receipt FHLB - Federal Home Loan Bank PC - Participation Certificate COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 43 Mutual European Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. 44 | Semiannual Report Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counterparty credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and its long-term relationship with the Fund as reasons that shareholders choose to invest, and remain Semiannual Report | 45 Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative 46 | Semiannual Report Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional European region funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the best performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the best performing quintile. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quintile and exceeded 10%, as shown in the Lipper Section 15(c) Report. The Board was satisfied with such comparative performance. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's best performing quintile of peer funds for the three-, five- and 10-year periods ended December 31, 2008. The trustees concluded that, while the Fund's losses over the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years and the reasons for any increases in the Fund's expense ratios. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense Semiannual Report | 47 Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the second most expensive quintile of its Lipper expense group and its total expenses were in the second least expensive quintile of such group. The Board was satisfied with such comparative expenses, noting that the Fund's contractual management fee rate was within 7.5 basis points of its Lipper expense group median. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative 48 | Semiannual Report Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) relationship of investment management and underwriting expenses; shareholder servicing profitability; economies of scale; and the relative contribution of the Fund to the profitability of the investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004. The trustees assessed the savings to shareholders resulting from such breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor the appropriateness of the breakpoints. The trustees also considered the effects Semiannual Report | 49 Mutual European Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. 50 | Semiannual Report This page intentionally left blank. This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL EUROPEAN FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B & C) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 478 S2009 08/09 (GRAPHIC) JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SECTOR MUTUAL FINANCIAL SERVICES FUND (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services. MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRAPHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ........................................................ 1 SEMIANNUAL REPORT Mutual Financial Services Fund ............................................ 4 Performance Summary ....................................................... 10 Your Fund's Expenses ...................................................... 13 Financial Highlights and Statement of Investments ......................... 15 Financial Statements ...................................................... 26 Notes to Financial Statements ............................................. 30 Shareholder Information ................................................... 46
Shareholder Letter Dear Mutual Financial Services Fund Shareholder: Financial markets reached historical extremes in the first half of 2009. In the U.S. and globally, the economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. During the period, the U.S. unemployment rate rose to its highest level in 25 years, housing prices continued their precipitous declines and 30-year U.S. Treasury yields plummeted to a 30-year low of around 2.5%, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of financial services companies on the scale of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of major bank nationalization was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The low in early March for the Standard & Poor's 500 Index -- down 26% from 2008 year-end and 57% from its peak in October 2007 -- was followed by a 42% rebound to its recent, second-quarter high on June 11.(1) The 57% drop was the third worst (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Standard & Poor's 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The index is one of the most widely used benchmarks of U.S. equity performance. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 since 1900.(1) At the same time, yields on 30-year Treasuries shot up to 4.8% in June, resulting in their worst six-month performance in over 16 years. European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed that the recovery in Europe would be slower than in the U.S. Trying to analyze the origin of investment bubbles, what prompts their demise and what ultimately causes markets to rebound when pessimism reigns supreme is a fascinating exercise but probably more art than science. Confidence plays an enormous role in the stability of our financial system, and the mere fact that the system did not collapse in March of this year set the stage for a huge rebound. More substantively, the results of the government "stress test" of major financial institutions were generally positive, enabling many of those institutions to raise capital in the public markets and avoid a worst-case scenario of government takeovers and/or failures of major banks. The self-reinforcing nature of raising capital lowered risk by enabling banks to absorb legacy losses, avoid fire-sale asset liquidations and generate new business at attractive spreads. Additionally, the bankruptcies of General Motors and Chrysler, although particularly painful for dealers, suppliers and those directly dependent on the auto industry, were absorbed without triggering further systemic risk. Investors began to grasp the "green shoots" as aggressively as they had looked for protection in a proverbial bunker a month or two before. Last year was especially disappointing for us at Franklin Mutual Advisers because we did not achieve our objective of preserving capital: our investors experienced significant losses in their portfolios. The good news so far this year is that Mutual Financial Services Fund is back in positive territory through June 30, although not nearly enough to offset last year's losses. We began the year in a fairly defensive posture and with a relatively high cash balance, as we chose over the course of 2008 to trim or exit some investments where we perceived the level of risk to be increasing. Nevertheless, the heightened fear in the marketplace began to open up attractive investment opportunities, and we selectively invested in a diverse group of undervalued equities, attractive merger arbitrage situations, and distressed debt opportunities. Late in 2008 and early in 2009, we began to find opportunities in senior secured corporate loans trading at levels we perceived reflected mispriced risk. These are exactly the types of opportunities that we patiently wait for and that we had not seen since the last big credit default cycle of 2001-2003, which included the frauds at Enron, Tyco and WorldCom. On the bankruptcy front recently, although the absolute number of bankruptcies increased, not many met the "good company, bad balance sheet" model we 2 | Not part of the semiannual report like, although we expect more of these as "covenant lite," highly leveraged balance sheets eventually reach a tipping point. On the merger and acquisition front, the market for corporate control collapsed in 2008 and early 2009 alongside the equity markets, as corporate boards suffered from the same uncertainty, risk aversion and credit unavailability as other investors. Managements had little visibility regarding their own near-term business prospects and minimal appetite to do anything other than hunker down. However, a few large health care deals did emerge as those acquirers took advantage of their relatively stable cash flows and strong balance sheets to pursue a needed rationalization of the industry. The good news here is that we believe the potential returns for these deals are as attractive as we have seen in many years, perhaps reflecting the memories of broken deals of 2008 and fewer players looking to invest in such situations. We expect an increase in mergers and acquisitions during the rest of 2009 as industry leaders consider further consolidation in a slow growth environment at prices that are still well below their peaks of 2007. While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of the U.S. to manage its enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited at this point of the cycle and hope that you share our enthusiasm as well. We appreciate your trust and support over the past 18 months and look forward to better investing times ahead. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual Financial Services Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Financial Services Fund seeks capital appreciation, with income as a secondary goal, by investing 80% of its net assets in securities of financial services companies that the manager believes are available at market prices less than their intrinsic value. The Fund concentrates its investments in securities of issuers such as banks, savings and loan organizations, credit card companies, brokerage firms, finance companies, subprime lending institutions, investment advisors, investment companies and insurance companies. We are pleased to bring you Mutual Financial Services Fund's semiannual report for the period ended June 30, 2009. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. PERFORMANCE OVERVIEW Mutual Financial Services Fund - Class Z delivered a +3.80% cumulative total return for the six months ended June 30, 2009. The Fund - Class Z outperformed its narrow benchmark, the Standard & Poor's 500 (S&P 500) Financials Index, which had a -3.41% total return, and its broad benchmark, the S&P 500, which had a +3.16% total return for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 10. ECONOMIC AND MARKET OVERVIEW During the six-month period ended June 30, 2009, the U.S. economy and stock markets seemed to stabilize after signs appeared that the recession's severity had eased. Strains on the banking system and credit markets that surfaced in 2008 improved in 2009's first half with the help of federal aid and tighter regulations. Despite rising unemployment, near period-end home sales (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 19. 4 | Semiannual Report edged higher, the decline in manufacturing activity slowed and consumer confidence started to pick up. Economic activity as measured by gross domestic product (GDP) fell at annualized rates of 6.4% and an estimated 1.0% in the first and second quarters of 2009. Although the price of oil rose from $44 per barrel at the beginning of the period to $70 by period-end on speculation that the downturn was abating, it was still off more than 50% from its July 2008 record high.(2) June's inflation rate, as measured by the Consumer Price Index, was an annualized -1.4%, representing the steepest yearly decline in the cost of living in nearly six decades.(3) Core inflation, which excludes food and energy costs, rose at a 1.7% annualized rate, which was within the Federal Reserve Board's (Fed's) informal target range of 1.5%-2.0%.(3) A deepening recession and decelerating inflation prompted Washington policy-makers to keep interest rates low and enact stimulus plans -- including income tax cuts, aid to ailing state governments and funding for transportation infrastructure, school construction and high-tech projects. During the period under review, the Fed kept the federal funds target rate in a range of 0% to 0.25% and said the "pace of economic contraction is slowing" but the financial system had not yet returned to normal. Most U.S. stocks suffered major losses through early March as investors worried about an uncertain future. Stocks then recovered somewhat from 12-year lows as investors perceived many bargains among the bear market fallout and data indicated the economy's pace of contraction was moderating. By June, however, fresh investor concerns about the economy and stock valuations reemerged and dampened the rally's momentum. For the six months under review, the blue chip stocks of the Dow Jones Industrial Average had a total return of -2.01%, while the broader S&P 500 posted a +3.16% total return and the technology-heavy NASDAQ Composite Index returned +16.99%.(4) Global equities followed the same trend. At the beginning of the period, with investor sentiment depressed and risk aversion elevated, defensive, non-cyclical sectors like utilities, consumer staples and health care were market leaders. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk appetite, rotating capital back into cyclical sectors such as financials, materials GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) U.S. 32.2% U.K. 8.7% Ireland 4.5% Germany 4.0% Bermuda 4.0% France 3.6% Australia 3.3% Italy 3.0% Norway 2.7% Greece 2.5% Hong Kong 2.4% China 2.3% Spain 2.0% Japan 1.5% Switzerland 1.1% Belgium 1.1% Other 2.3% Short-Term Investments & Other Net Assets 18.8%
(2.) Source: New York Mercantile Exchange. (3.) Source: Bureau of Labor Statistics. (4.) Source: (C) 2009 Morningstar. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. Semiannual Report | 5 and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging market optimism in turn supported higher commodity prices, which gained the most since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar at the beginning of the period, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the six-month period. In the reporting period's final weeks, global equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(5) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(6) INVESTMENT STRATEGY We strive to provide investors with superior risk-adjusted returns over time through our distinctive, value investment style, which includes investments in undervalued common stocks, distressed debt and risk arbitrage. Rigorous fundamental analysis drives our investment process. We attempt to determine each investment's intrinsic value as well as the price at which we would be willing to commit shareholder funds. While valuation remains our key consideration, we utilize numerous fundamental factors such as return on equity, financial leverage and long-term earnings power. We also consider factors such as management quality and competitive position. As always, our approach to successful investing is as much about assessing risk and containing losses as it is about achieving profits. WHAT IS RETURN ON EQUITY? Return on equity is an amount, expressed as a percentage, earned on a company's common stock investment for a given period. It is calculated by dividing common stock equity (net worth) over the average of the accounting period into net income for the period after preferred stock dividends but before common stock dividends. Return on equity tells common shareholders how effectually their money is being employed. Comparing percentages for current and prior periods also reveals trends, and comparison with industry composites reveals how well a company is holding its own against its competitors. (5.) Source: European Communities Eurostat. (6.) Source: People's Bank of China. 6 | Semiannual Report In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION The first half of 2009 was a volatile mix of difficulty and resurgence for the financial services sector globally. Against this backdrop, the Fund's largest contributors included Hellenic Exchanges, a holding company for a number of organizations that support the Greek capital market's structure and operation; CNinsure, an independent Chinese insurance agency and brokerage firm; and Bank of Ireland. In an about-face from 2008, Hellenic Exchanges rebounded sharply and appreciated in the first half of 2009. This company's appeal was largely unchanged, in our view, as it continued to be a highly cash generative business with ongoing cost controls and a revenue model that was insulated from much of the competition that plagued other global cash exchanges. The rekindling of equity trading in the first quarter of this year marked a critical turning point for the business as volumes accelerated. Further supporting Hellenic's stock price was the May payment of a E0.41 per share dividend, equating to a dividend yield of nearly 7% based on the company's average stock price over the period. We continued to hold the stock at period-end, believing Hellenic to be a solid business trading at a very inexpensive valuation. CNinsure operates in China where there is an emerging and growing need for insurance products as citizens acquire property and seek to protect their health or savings. While we are closely monitoring the underwriting standards in this nascent market, we invested in CNinsure partially because it holds the largest agency presence in China. This has helped sales increase 58% year-over-year through March 2009 with margins of more than 20%. Also, the company's balance sheet was flush with cash. In our view, CNinsure's stock was undervalued considering its growth and profitability, and we continued to hold the position at period-end. PORTFOLIO BREAKDOWN Based on Total Net Assets as of 6/30/09 (BAR CHART) Insurance 33.8% Diversified Financial Services 13.2% Commercial Banks 13.2% Corporate Bonds & Notes 5.6% Thrifts & Mortgage Finance 4.6% Real Estate Investment Trusts 2.6% Capital Markets 1.7% Real Estate Management & Development 1.5% Media 1.0% Other 4.0% Short-Term Investments & Other Net Assets 18.8%
Bank of Ireland was a substantial Fund investment several years ago that we sold at the end of 2006 for more than E16 per share. We bought it back in the second quarter of 2009 at a fraction of our exit price -- E0.84 per share. Our longer term investors may remember that earlier in the decade, we thought Bank of Ireland's attraction was its leading market position and the growth of the Irish economy combined with an anomalous valuation. Although the company benefited from these factors, during the global banking crisis Ireland found it had one of the world's most challenged financial systems due to plummeting property values and serious concerns over capital levels. The state of Semiannual Report | 7 the Irish banking system was so severe that at one point during first quarter 2009 its total market capitalization of about E500 million was only 0.25% of the country's 2008 GDP. This was virtually unheard of in a developed market. The incredibly cheap valuation and distressed nature of these banks caught our attention and, consequently, we acquired equity as well as debt from the entire sector during the reporting period. Our foray was established on the thesis that credit losses were absorbable and government support would be adequate to ensure the system's survival. This thesis was validated as the stock appreciated over our holding period and continued to trade at what we considered highly attractive valuations at period-end. TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- Deutsche Boerse AG 3.5% DIVERSIFIED FINANCIAL SERVICES, GERMANY Symetra Financial 3.3% INSURANCE, U.S. Maiden Holdings Ltd., 144A 3.0% INSURANCE, U.S. Intesa Sanpaolo SpA, ord. & di Risp 2.6% COMMERCIAL BANKS, ITALY BNP Paribas SA 2.3% COMMERCIAL BANKS, FRANCE Hellenic Exchanges SA Holding 2.3% DIVERSIFIED FINANCIAL SERVICES, GREECE CNinsure Inc., ADR 2.3% INSURANCE, CHINA Lancashire Holdings Ltd. 2.2% INSURANCE, U.K. AmTrust Financial Services Inc. 2.1% INSURANCE, U.S. Bolsas Y Mercados Espanoles 2.0% DIVERSIFIED FINANCIAL SERVICES, SPAIN
In contrast, some of the Fund's worst-performing investments were PacWest Bancorp, which operates about 60 branches in Southern California and targets its services to small to midsized businesses; First Chicago Bancorp, another provider of commercial banking services primarily to small and medium Midwestern companies; and White Mountains Insurance Group, which provides insurance and reinsurance products and services. The value of the Fund's investment in PacWest was nearly halved during the first six months of 2009. Investor fears arose about a broad-based deterioration in California's economy that could lead to significant losses for commercial-based banks such as PacWest. As market sentiment weighed heavily on the share price, its valuation multiple compressed substantially during the reporting period. We subsequently sold the Fund's PacWest position by period-end. Our position in First Chicago is a private investment in a commercial-based bank that the Fund has held for several years. Similar to PacWest, First Chicago also faced difficulties in the first half of 2009 as losses from commercial real estate loans in the Chicago area accelerated and the company's capital levels fell. Given the deterioration in the bank's fundamentals, as well as a drop in the share prices of comparable banks during the period, the Fund's investment lost value. White Mountains suffered early in the year from an investment portfolio leveraged to equities, what the company saw as a mismanaged life reinsurance portfolio in Japan, and the subsequent erosion of its capital position that was exacerbated by the buy-back of Berkshire Hathaway's holding. The company took corrective actions by reducing its equity exposure and neutralizing its life reinsurance book with a view to exiting that business. The company's core underwriting businesses were apparently performing well, however, and at period-end we think the stock could recover from these oversold levels if the market recognizes what we see as the intrinsic value of these businesses. 8 | Semiannual Report Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during the first half of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual Financial Services Fund. We look forward to serving your future investment needs. (PHOTO OF CHARLES M. LAHR) /s/ Charles M. Lahr Charles M. Lahr, CFA Portfolio Manager Mutual Financial Services Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. CHARLES LAHR has been portfolio manager for Mutual Financial Services Fund since 2004. He is also portfolio manager for Mutual Global Discovery Fund. He joined Franklin Templeton Investments in 2003. Previously, he was a senior analyst for the State of Wisconsin Investment Board and also worked for U.S. Bancorp and the Principal Financial Group. Semiannual Report | 9 Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: TEFAX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.41 $11.21 $10.80
CLASS A (SYMBOL: TFSIX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.39 $11.22 $10.83
CLASS B (SYMBOL: TBFSX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.34 $10.95 $10.61
CLASS C (SYMBOL: TMFSX) CHANGE 6/30/09 12/31/08 - ----------------------- ------ ------- -------- Net Asset Value (NAV) +$0.35 $11.15 $10.80
10 | Semiannual Report Performance Summary (CONTINUED) PERFORMANCE(1) CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY.
CLASS Z 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- ------- Cumulative Total Return(2) +3.80% -20.04% -12.90% +60.86% Average Annual Total Return(3) +3.80% -20.04% -2.72% +4.87% Value of $10,000 Investment(4) $10,380 $ 7,996 $ 8,710 $16,086 Total Annual Operating Expenses(5) 1.19%
CLASS A 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- ------- Cumulative Total Return(2) +3.60% -20.31% -14.20% +55.73% Average Annual Total Return(3) -2.35% -24.91% -4.16% +3.91% Value of $10,000 Investment(4) $ 9,765 $ 7,509 $ 8,086 $14,677 Total Annual Operating Expenses(5) 1.49%
CLASS B 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- ------- Cumulative Total Return(2) +3.20% -20.87% -17.13% +47.72% Average Annual Total Return(3) -0.80% -23.97% -3.95% +3.98% Value of $10,000 Investment(4) $ 9,920 $ 7,603 $ 8,177 $14,772 Total Annual Operating Expenses(5) 2.19%
CLASS C 6-MONTH 1-YEAR 5-YEAR 10-YEAR - ------- ------- ------- ------- ------- Cumulative Total Return(2) +3.24% -20.83% -17.07% +45.66% Average Annual Total Return(3) +2.24% -21.61% -3.68% +3.83% Value of $10,000 Investment(4) $10,224 $ 7,839 $ 8,293 $14,566 Total Annual Operating Expenses(5) 2.19%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. Semiannual Report | 11 Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. INVESTING IN A SINGLE-SECTOR FUND INVOLVES SPECIAL RISKS, INCLUDING GREATER SENSITIVITY TO ECONOMIC, POLITICAL OR REGULATORY DEVELOPMENTS IMPACTING THE SECTOR. IN ADDITION, THE FUND INVESTS IN FOREIGN SECURITIES WHOSE RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS CARRY AN INCREASED RISK OF PRICE FLUCTUATION, PARTICULARLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. (1.) Past expense reductions by the Fund's manager increased the Fund's total returns. If the manager had not taken this action, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the periods indicated. (3.) Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has not been annualized. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. 12 | Semiannual Report Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. Semiannual Report | 13 Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING VALUE 1/1/09 VALUE 6/30/09 PERIOD* 1/1/09-6/30/09 ----------------- -------------- ---------------------- CLASS Z Actual $1,000 $1,038.00 $ 6.42 Hypothetical (5% return before expenses) $1,000 $1,018.50 $ 6.36 CLASS A Actual $1,000 $1,036.00 $ 7.82 Hypothetical (5% return before expenses) $1,000 $1,017.11 $ 7.75 CLASS B Actual $1,000 $1,032.00 $11.44 Hypothetical (5% return before expenses) $1,000 $1,013.54 $11.33 CLASS C Actual $1,000 $1,032.40 $11.44 Hypothetical (5% return before expenses) $1,000 $1,013.54 $11.33
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.27%; A: 1.55%; B: 2.27%; and C: 2.27%), multiplied by the average account value over the period, multiplied by 181/365 to reflect the one-half year period. 14 | Semiannual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------- CLASS Z (UNAUDITED) 2008 2007 2006 2005 2004 - ------- ---------------- --------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ........... $ 10.80 $ 18.68 $ 22.59 $ 21.59 $ 20.45 $ 20.06 ------- ------- -------- -------- -------- -------- Income from investment operations(a): Net investment income(b) .................... 0.01(c) 0.46 0.51 0.40 0.44 0.34 Net realized and unrealized gains (losses) .. 0.40 (7.94) (2.41) 3.76 2.40 2.70 ------- ------- -------- -------- -------- -------- Total from investment operations ............... 0.41 (7.48) (1.90) 4.16 2.84 3.04 ------- ------- -------- -------- -------- -------- Less distributions from: Net investment income ....................... -- (0.40) (0.61) (0.57) (0.49) (0.32) Net realized gains .......................... -- -- (1.40) (2.59) (1.21) (2.33) ------- ------- -------- -------- -------- -------- Total distributions ............................ -- (0.40) (2.01) (3.16) (1.70) (2.65) ------- ------- -------- -------- -------- -------- Redemption fees(d) ............................. -- --(e) --(e) --(e) --(e) --(e) ------- ------- -------- -------- -------- -------- Net asset value, end of period ................. $ 11.21 $ 10.80 $ 18.68 $ 22.59 $ 21.59 $ 20.45 ======= ======= ======== ======== ======== ======== Total return(f) ................................ 3.80% (40.08)% (8.71)% 19.73% 14.14% 15.62% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ........... 1.28% 1.19% 1.11% 1.08% 1.12% 1.10% Expenses net of expense reduction(h) ........... 1.27% 1.19% 1.11% 1.08% 1.12% 1.10% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ........... 1.27% 1.18% 1.11% 1.08% 1.11% 1.09% Expenses net of expense reduction ........... 1.26% 1.18% 1.11% 1.08% 1.11% 1.09% Net investment income .......................... 0.08%(c) 3.15% 2.25% 1.71% 2.10% 1.65% SUPPLEMENTAL DATA Net assets, end of period (000's) .............. $90,299 $91,691 $164,890 $213,874 $174,864 $166,175 Portfolio turnover rate ........................ 35.66% 41.98% 49.87% 62.65% 31.71% 38.40%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.09) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.86%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 15 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------- CLASS A (UNAUDITED) 2008 2007 2006 2005 2004 ---------------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ........... $ 10.83 $ 18.70 $ 22.60 $ 21.61 $ 20.47 $ 20.08 -------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income (loss)(b) ............. (0.01)(c) 0.42 0.44 0.33 0.37 0.27 Net realized and unrealized gains (losses) .. 0.40 (7.93) (2.40) 3.76 2.41 2.70 -------- -------- -------- -------- -------- -------- Total from investment operations ............... 0.39 (7.51) (1.96) 4.09 2.78 2.97 -------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ....................... -- (0.36) (0.54) (0.51) (0.43) (0.25) Net realized gains .......................... -- -- (1.40) (2.59) (1.21) (2.33) -------- -------- -------- -------- -------- -------- Total distributions ............................ -- (0.36) (1.94) (3.10) (1.64) (2.58) -------- -------- -------- -------- -------- -------- Redemption fees(d) ............................. -- --(e) --(e) --(e) --(e) --(e) -------- -------- -------- -------- -------- -------- Net asset value, end of period ................. $ 11.22 $ 10.83 $ 18.70 $ 22.60 $ 21.61 $ 20.47 ======== ======== ======== ======== ======== ======== Total return(f) ................................ 3.60% (40.23)% (8.99)% 19.35% 13.82% 15.17% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ........... 1.56% 1.49% 1.40% 1.39% 1.42% 1.44% Expenses net of expense reduction(h) ........... 1.55% 1.49% 1.40% 1.39% 1.42% 1.44% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ........... 1.55% 1.48% 1.40% 1.39% 1.41% 1.43% Expenses net of expense reduction ........... 1.54% 1.48% 1.40% 1.39% 1.41% 1.43% Net investment income (loss) ................... (0.20)%(c) 2.85% 1.96% 1.40% 1.80% 1.31% SUPPLEMENTAL DATA Net assets, end of period (000's) .............. $252,688 $260,479 $441,180 $557,768 $359,058 $296,778 Portfolio turnover rate ........................ 35.66% 41.98% 49.87% 62.65% 31.71% 38.40%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.09) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 1.58%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 ---------------------------------------------------- CLASS B (UNAUDITED) 2008 2007 2006 2005 2004 ---------------- ------- ------- ------- ------- ------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ........... $ 10.61 $ 18.26 $ 22.08 $ 21.17 $ 20.09 $ 19.76 --------- ------- ------- ------- ------- ------- Income from investment operations(a): Net investment income (loss)(b) ............. (0.05)(c) 0.31 0.27 0.16 0.23 0.14 Net realized and unrealized gains (losses) .. 0.39 (7.72) (2.33) 3.68 2.34 2.64 --------- ------- ------- ------- ------- ------- Total from investment operations ............... 0.34 (7.41) (2.06) 3.84 2.57 2.78 --------- ------- ------- ------- ------- ------- Less distributions from: Net investment income ....................... -- (0.24) (0.36) (0.34) (0.28) (0.12) Net realized gains .......................... -- -- (1.40) (2.59) (1.21) (2.33) --------- ------- ------- ------- ------- ------- Total distributions ............................ -- (0.24) (1.76) (2.93) (1.49) (2.45) --------- ------- ------- ------- ------- ------- Redemption fees(d) ............................. -- --(e) --(e) --(e) --(e) --(e) --------- ------- ------- ------- ------- ------- Net asset value, end of period ................. $ 10.95 $ 10.61 $ 18.26 $ 22.08 $ 21.17 $ 20.09 ========= ======= ======= ======= ======= ======= Total return(f) ................................ 3.20% (40.66)% (9.58)% 18.51% 13.03% 14.51% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ........... 2.28% 2.19% 2.11% 2.08% 2.12% 2.10% Expenses net of expense reduction(h) ........... 2.27% 2.19% 2.11% 2.08% 2.12% 2.10% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ........... 2.27% 2.18% 2.11% 2.08% 2.11% 2.09% Expenses net of expense reduction ........... 2.26% 2.18% 2.11% 2.08% 2.11% 2.09% Net investment income (loss) ................... (0.92)%(c) 2.15% 1.25% 0.71% 1.10% 0.65% SUPPLEMENTAL DATA Net assets, end of period (000's) .............. $ 11,117 $13,185 $30,756 $46,085 $42,526 $42,614 Portfolio turnover rate ........................ 35.66% 41.98% 49.87% 62.65% 31.71% 38.40%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.09) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.86%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, 2009 -------------------------------------------------------- CLASS C (UNAUDITED) 2008 2007 2006 2005 2004 ---------------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period ........... $ 10.80 $ 18.59 $ 22.46 $ 21.51 $ 20.39 $ 20.02 ------- -------- -------- -------- -------- -------- Income from investment operations(a): Net investment income (loss)(b) ............. (0.05)(c) 0.31 0.28 0.16 0.23 0.13 Net realized and unrealized gains (losses) .. 0.40 (7.85) (2.37) 3.73 2.38 2.68 ------- -------- -------- -------- -------- -------- Total from investment operations ............... 0.35 (7.54) (2.09) 3.89 2.61 2.81 ------- -------- -------- -------- -------- -------- Less distributions from: Net investment income ....................... -- (0.25) (0.38) (0.35) (0.28) (0.11) Net realized gains .......................... -- -- (1.40) (2.59) (1.21) (2.33) ------- -------- -------- -------- -------- -------- Total distributions ............................ -- (0.25) (1.78) (2.94) (1.49) (2.44) ------- -------- -------- -------- -------- -------- Redemption fees(d) ............................. -- --(e) --(e) --(e) --(e) --(e) ------- -------- -------- -------- -------- -------- Net asset value, end of period ................. $ 11.15 $ 10.80 $ 18.59 $ 22.46 $ 21.51 $ 20.39 ======= ======== ======== ======== ======== ======== Total return(f) ................................ 3.24% (40.63)% (9.60)% 18.52% 13.06% 14.46% RATIOS TO AVERAGE NET ASSETS(g) Expenses before expense reduction(h) ........... 2.28% 2.19% 2.11% 2.08% 2.12% 2.10% Expenses net of expense reduction(h) ........... 2.27% 2.19% 2.11% 2.08% 2.12% 2.10% Ratios to average net assets, excluding dividend expense on securities sold short: Expenses before expense reduction ........... 2.27% 2.18% 2.11% 2.08% 2.11% 2.09% Expenses net of expense reduction ........... 2.26% 2.18% 2.11% 2.08% 2.11% 2.09% Net investment income (loss) ................... (0.92)%(c) 2.15% 1.25% 0.71% 1.10% 0.65% SUPPLEMENTAL DATA Net assets, end of period (000's) .............. $98,419 $103,509 $183,684 $225,305 $169,000 $155,698 Portfolio turnover rate ........................ 35.66% 41.98% 49.87% 62.65% 31.71% 38.40%
(a) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (b) Based on average daily shares outstanding. (c) Net investment income per share includes approximately ($0.09) per share related to a reserve for uncollectible interest as disclosed on the Statement of Operations. Excluding the effect of this adjustment, the ratio of net investment income to average net assets would have been 0.86%. See Note 8. (d) Effective September 1, 2008, the redemption fee was eliminated. (e) Amount rounds to less than $0.01 per share. (f) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (g) Ratios are annualized for periods less than one year. (h) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
SHARES/ COUNTRY RIGHTS VALUE ------------------------ ---------- ------------ COMMON STOCKS AND OTHER EQUITY INTERESTS 75.3% BEVERAGES 0.2% Lion Nathan Ltd. ........................................ Australia 81,533 $ 759,622 ------------ CAPITAL MARKETS 1.7% (a) FBR Capital Markets Corp. ............................... United States 13,000 61,100 Man Group PLC ........................................... United Kingdom 1,452,144 6,630,266 Marfin Investment Group Holdings SA ..................... Greece 224,615 964,038 ------------ 7,655,404 ------------ COMMERCIAL BANKS 13.2% (a, b) AB&T Financial Corp. .................................... United States 226,100 1,045,713 Allied Irish Banks PLC .................................. Ireland 1,094,102 2,659,439 (a, b, c) Atlantic Banc Holdings Inc. ............................. United States 350,000 2,279,763 Banca Popolare di Milano SCRL ........................... Italy 263,277 1,567,561 (a) Bank of Ireland ......................................... Ireland 2,121,990 5,029,953 Bank of Ireland, ADR .................................... Ireland 400 3,816 (a, c) The Bankshares Inc. ..................................... United States 456,903 1,737,999 Barclays PLC ............................................ United Kingdom 805,757 3,751,879 BNP Paribas SA .......................................... France 161,842 10,498,732 (a) Cape Bancorp Inc. ....................................... United States 264,663 2,284,042 (a) Chicopee Bancorp Inc. ................................... United States 286,714 3,718,681 (a, c) Elephant Capital Holdings Ltd. .......................... Japan 5,268 -- (a, c) First Chicago Bancorp ................................... United States 496,868 1,253,161 (a) Guaranty Bancorp ........................................ United States 1,333,807 2,547,571 (a) Intesa Sanpaolo SpA ..................................... Italy 2,656,685 8,551,782 Intesa Sanpaolo SpA, di Risp ............................ Italy 1,383,272 3,406,952 (a, c) NCB Warrant Holdings Ltd., A ............................ Japan 25,741 -- (a) Royal Bank of Scotland Group PLC ........................ United Kingdom 1,897,380 1,206,284 Societe Generale, A ..................................... France 103,730 5,657,445 (a) Southern National Bancorp of Virginia Inc. .............. United States 290,840 2,384,888 SunTrust Banks Inc. ..................................... United States 12,300 202,335 ------------ 59,787,996 ------------ COMMERCIAL SERVICES & SUPPLIES 0.4% (a) Comdisco Holding Co. Inc. ............................... United States 103 752 (a, d) Comdisco Holding Co. Inc., Contingent Distribution ...... United States 4,195,000 -- (a, e) Protection One Inc. ..................................... United States 370,533 1,585,881 ------------ 1,586,633 ------------ CONSUMER FINANCE 0.6% (a, c) Cerberus CG Investor I LLC .............................. United States 1,139,363 216,479 (a, c) Cerberus CG Investor II LLC ............................. United States 1,139,363 216,479 (a, c) Cerberus CG Investor III LLC ............................ United States 569,682 108,239 (a, c) Cerberus FIM Investors Holdco LLC ....................... United States 4,357,178 317,203 (a) White River Capital Inc. ................................ United States 172,799 1,611,351 ------------ 2,469,751 ------------ DIVERSIFIED FINANCIAL SERVICES 12.8% Bolsas Y Mercados Espanoles ............................. Spain 309,433 9,148,946 Deutsche Boerse AG ...................................... Germany 201,619 15,632,677 (a) Fortis .................................................. Belgium 1,448,950 4,938,483 (a, f) Fortis, rts., 7/01/14 ................................... Belgium 422,790 -- (a) Global Consumer Acquisition ............................. United States 700 6,762
Semiannual Report | 19 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ COUNTRY RIGHTS VALUE ------------------------ ---------- ------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED FINANCIAL SERVICES (CONTINUED) Guinness Peat Group PLC ................................. United Kingdom 6,691,384 $ 2,935,296 Hellenic Exchanges SA Holding ........................... Greece 932,280 10,474,004 Osaka Securities Exchange Co. Ltd. ...................... Japan 1,023 4,915,411 Oslo Bors VPS Holding ASA ............................... Norway 911,000 8,142,906 (a) Resolution Ltd. ......................................... United Kingdom 1,277,539 1,870,779 ------------ 58,065,264 ------------ FOOD & STAPLES RETAILING 0.4% AWB Ltd. ................................................ Australia 2,016,058 1,915,648 ------------ FOOD PRODUCTS 0.4% First Pacific Co. Ltd. .................................. Hong Kong 3,040,000 1,745,571 ------------ HOUSEHOLD DURABLES 0.6% (a) Berkeley Group Holdings PLC ............................. United Kingdom 195,484 2,587,591 ------------ INDUSTRIAL CONGLOMERATES 0.2% Jardine Matheson Holdings Ltd. .......................... Hong Kong 17,757 486,897 Jardine Strategic Holdings Ltd. ......................... Hong Kong 31,565 465,268 ------------ 952,165 ------------ INSURANCE 33.8% ACE Ltd. . ............................................. United States 146,560 6,482,349 AmTrust Financial Services Inc. ......................... United States 840,831 9,585,473 a Argo Group International Holdings Ltd. ................ United States 271,110 7,650,724 Aspen Insurance Holdings Ltd. ........................... United States 169,680 3,790,651 Austbrokers Holdings Ltd. ............................... Australia 339,153 1,078,757 (a) Berkshire Hathaway Inc., A .............................. United States 37 3,330,000 (a) Berkshire Hathaway Inc., B .............................. United States 216 625,478 Brit Insurance Holdings PLC ............................. United Kingdom 1,307,504 4,065,960 Catlin Group Ltd. ....................................... United Kingdom 917,138 4,851,477 CNinsure Inc., ADR ...................................... China 780,660 10,468,651 (a) Enstar Group Ltd. ....................................... United States 113,109 6,656,465 Fidelity National Financial Inc., A ..................... United States 88,649 1,199,421 (a) Hilltop Holdings Inc. ................................... United States 381,500 4,528,405 (a, c) Imagine Group Holdings Ltd. ............................. Bermuda 551,589 5,024,810 Irish Life & Permanent PLC .............................. Ireland 636,151 3,127,390 (a) Lancashire Holdings Ltd. ................................ United Kingdom 1,317,766 10,098,328 Maiden Holdings Ltd. .................................... United States 564,590 3,703,710 (g) Maiden Holdings Ltd., 144A .............................. United States 1,500,000 9,840,000 (a, c) Olympus Re Holdings Ltd. ................................ United States 7,480 16,347 Partnerre Ltd. .......................................... Bermuda 104,810 6,807,409 (b) Protector Forsikring ASA ................................ Norway 4,479,410 4,195,378 (a, c) Symetra Financial ....................................... United States 1,020,510 14,960,677 Tower Australia Group Ltd. .............................. Australia 3,126,817 7,050,034 The Travelers Cos. Inc. ................................. United States 175,143 7,187,869 Validus Holdings Ltd. ................................... Bermuda 211,650 4,652,067 White Mountains Insurance Group Ltd. .................... United States 38,048 8,709,568 Zurich Financial Services AG ............................ Switzerland 18,120 3,190,880 ------------ 152,878,278 ------------
20 | Semiannual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
SHARES/ COUNTRY RIGHTS VALUE ------------------------ ---------- ------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) LEISURE EQUIPMENT & PRODUCTS 0.2% Hutichison Harbour Ring Ltd. ............................ Hong Kong 14,046,000 $ 1,069,322 ------------ MEDIA 1.0% Seven Network Ltd. ...................................... Australia 993,284 4,287,153 ------------ MULTILINE RETAIL 0.4% Jelmoli Holding AG ...................................... Switzerland 5,195 1,883,182 ------------ PHARMACEUTICALS 0.4% Wyeth ................................................... United States 41,100 1,865,529 ------------ REAL ESTATE INVESTMENT TRUSTS (REITS) 2.6% Chimera Investment Corp. ................................ United States 426,000 1,486,740 Link REIT ............................................... Hong Kong 3,308,504 7,061,079 (a) Walter Investment Management Corp. ...................... United States 243,660 3,235,805 ------------ 11,783,624 ------------ REAL ESTATE MANAGEMENT & DEVELOPMENT 1.8% Conwert Immobilien Invest SE ............................ Austria 298,133 2,408,610 (a) Dolphin Capital Investors Ltd. .......................... Virgin Islands (British) 3,979,650 2,553,688 Eurocastle Investment Ltd. .............................. Guernsey Islands 1,483,229 686,524 Franconofurt AG ......................................... Germany 201,927 860,997 Gagfah SA ............................................... Germany 195,759 1,636,447 (c) Star Asia Finance Ltd., 144A ............................ Japan 96,850 199,036 ------------ 8,345,302 ------------ THRIFTS & MORTGAGE FINANCE 4.6% Abington Bancorp Inc. ................................... United States 782,830 6,231,327 Danvers Bancorp Inc. .................................... United States 52,901 711,519 ESSA Bancorp Inc. ....................................... United States 45,830 626,496 (b) First Clover Leaf Financial Corp. ....................... United States 436,070 3,096,097 Viewpoint Financial Group ............................... United States 395,549 6,024,211 Westfield Financial Inc. ................................ United States 474,380 4,297,883 ------------ 20,987,533 ------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $435,144,735) 340,625,568 ------------ PREFERRED STOCKS (COST $2,339,859) 0.4% DIVERSIFIED FINANCIAL SERVICES 0.4% (a, c) Hightower Holding LLC, pfd. ............................. United States 2,339,859 1,899,263 ------------
PRINCIPAL AMOUNT(h) ---------- CORPORATE BONDS & NOTES 5.6% (i) ABN Amro Bank NV, sub. note, series 752, 5.00%, Perpetual ............................................ Netherlands 1,500,000 GBP 1,345,074 (g) Aiful Corp., senior note, 144A, 4.45%, 2/16/10 .......... Japan 2,000,000 1,460,186 Allied Irish Banks PLC, sub. bond, 12.50%, 6/25/19 ...... Ireland 2,576,000 EUR 3,378,246 American General Finance Corp., 5.85%, 6/01/13 ....................................... United States 66,000 37,901 senior note, J, 6.90%, 12/15/17 ...................... United States 930,000 504,241 (g, i) Catlin Insurance Co. Ltd., pfd., 144A, 7.249%, Perpetual ............................................ Bermuda 3,000,000 1,605,000
Semiannual Report | 21 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(h) VALUE ------------------------ ---------- ------------ CORPORATE BONDS & NOTES (CONTINUED) (c, j) Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............. United States 1,000,000 $ 190,000 (c, j) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ............ United States 1,000,000 190,000 (c, j) Cerberus CG Investor III LLC, 12.00%, 7/31/14 ........... United States 500,000 95,000 (c, j) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ..... United States 12,895,188 938,138 (i) Chess Capital Securities, 4.83%, Perpetual .............. Ireland 16,200,000 EUR 6,134,973 (i) EGG Banking PLC, sub. note, series 19, 7.50%, Perpetual.. United Kingdom 1,740,000 GBP 1,433,592 (f, i , k) Eurocastle Investment Ltd., sub. note cvt., Reg S, 20.00%, Perpetual ............................................ Guernsey Islands 1,584,790 EUR 2,200,598 (l) Hannover Finance SA, senior sub. note, FRN, 5.75%, 2/26/24 .............................................. Luxembourg 1,030,000 EUR 1,197,783 (l) JP Morgan Chase & Co., senior note, C, FRN, 0.734%, 12/21/11 ............................................. United States 1,113,000 1,078,304 (c, l, m, n) Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 ... United States 2,714,922 2,605,112 (c, l, m, n) Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 .................................. United States 430,639 750,208 ------------ TOTAL CORPORATE BONDS & NOTES (COST $37,063,050) ........ 25,144,356 ------------ TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $474,547,644) .................................. 367,669,187 ------------ SHORT TERM INVESTMENTS 21.1% U.S. GOVERNMENT AND AGENCY SECURITIES 21.1% (o) FHLB, 7/01/09 ........................................... United States 3,600,000 3,599,999 (o) U.S. Treasury Bills, 7/02/09 .............................................. United States 5,000,000 4,999,995 7/09/09 .............................................. United States 5,000,000 4,999,905 7/16/09 .............................................. United States 5,000,000 4,999,800 7/23/09 .............................................. United States 5,000,000 4,999,665 7/30/09 .............................................. United States 5,000,000 4,999,390 8/06/09 .............................................. United States 7,000,000 6,998,985 8/13/09 .............................................. United States 5,000,000 4,999,135 8/20/09 .............................................. United States 5,000,000 4,998,980 9/03/09 .............................................. United States 5,000,000 4,998,800 (p) 9/17/09 .............................................. United States 5,000,000 4,998,160 9/24/09 .............................................. United States 5,000,000 4,998,110 10/08/09 ............................................. United States 5,000,000 4,997,565 10/15/09 ............................................. United States 5,000,000 4,997,350 10/22/09 ............................................. United States 5,000,000 4,997,020 10/29/09 ............................................. United States 5,000,000 4,996,965 11/05/09 ............................................. United States 5,000,000 4,996,385 12/17/09 ............................................. United States 5,000,000 4,992,560 12/24/09 ............................................. United States 5,000,000 4,992,005 ------------ TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $95,534,571) ................................... 95,560,774 ------------ TOTAL INVESTMENTS BEFORE MONEY MARKET FUNDS (COST $570,082,215) .................................. 463,229,961 ------------
22 | Semiannual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY SHARES VALUE ------------------------ ---------- ------------ (q) INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.0%(r) MONEY MARKET FUNDS (COST $115,873) 0.0%(r) (s) Bank of New York Institutional Cash Reserve Fund, 0.12%.. United States 115,873 $ 114,714 ------------ TOTAL INVESTMENTS (COST $570,198,088) 102.4% ............ 463,344,675 SECURITIES SOLD SHORT (0.1)% ............................ (607,245) OTHER ASSETS, LESS LIABILITIES (2.3)% ................... (10,214,262) ------------ NET ASSETS 100.0% ....................................... $452,523,168 ============ (t) SECURITIES SOLD SHORT (PROCEEDS $621,027) 0.1% PHARMACEUTICALS 0.1% Pfizer Inc. ............................................. United States 40,483 $ 607,245 ------------
(a) Non-income producing. (b) See Note 12 regarding holdings of 5% voting securities. (c) See Note 9 regarding restricted securities. (d) Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (e) A portion or all of the security is on loan at June 30, 2009. See Note 1(g). (f) Security has been deemed illiquid because it may not be able to be sold within seven days. At June 30, 2009, the aggregate value of these securities was $2,200,598, representing 0.49% of net assets. (g) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Trust's Board of Trustees. At June 30, 2009, the aggregate value of these securities was $12,905,186, representing 2.85% of net assets. (h) The principal amount is stated in U.S. dollars unless otherwise indicated. (i) Perpetual security with no stated maturity date. (j) See Note 8 regarding credit risk and defaulted securities. (k) Income may be received in additional securities and/or cash. (l) The coupon rate shown represents the rate at period end. (m) See Note 13 regarding other considerations. (n) See Note 1(f) regarding special purpose entities. (o) The security is traded on a discount basis with no stated coupon rate. (p) Security or a portion of the security has been segregated as collateral for securities sold short. At June 30, 2009, the value of securities and/or cash pledged amounted to $1,650,527. (q) See Note 1(g) regarding securities on loan. (r) Rounds to less than 0.1% of net assets. (s) The rate shown is the annualized seven-day yield at period end. (t) See Note 1(e) regarding securities sold short. Semiannual Report | 23 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED) At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(c).
SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY CONTRACT AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- -------- --------------- ---------- ------------ ------------ British Pound ....... SSBT Sell 18,917,874 $29,290,407 7/13/09 $ -- $(1,835,639) British Pound ....... HSBC Sell 1,699,110 2,628,560 7/13/09 -- (167,027) British Pound ....... BANT Buy 1,095,000 1,518,116 7/13/09 283,514 -- British Pound ....... SSBT Buy 1,498,100 2,129,246 7/13/09 335,616 -- British Pound ....... BANT Sell 1,952,171 3,214,565 7/13/09 424 -- Euro ................ SSBT Sell 5,432,030 7,430,940 7/27/09 -- (188,152) Euro ................ DBFX Sell 900,000 1,227,123 7/27/09 -- (35,238) Euro ................ HSBC Sell 340,000 461,547 7/27/09 -- (15,345) Swiss Franc ......... BANT Sell 16,540,813 14,270,429 8/10/09 -- (956,229) Swiss Franc ......... HSBC Sell 699,600 620,001 8/10/09 -- (24,017) Swiss Franc ......... HAND Sell 100,166 90,000 8/10/09 -- (2,208) Swiss Franc ......... SSBT Buy 12,102,174 10,467,473 8/10/09 673,193 -- British Pound ....... DBFX Sell 1,130,000 1,839,414 8/12/09 -- (19,719) Euro ................ BBU Sell 1,000,000 1,335,220 8/13/09 -- (67,353) Euro ................ HSBC Sell 1,051,338 1,429,715 8/13/09 -- (44,864) Euro ................ BANT Sell 400,000 536,260 8/13/09 -- (24,769) Euro ................ SSBT Sell 9,706,899 13,629,585 8/13/09 14,952 -- Norwegian Krone ..... HAND Sell 68,557,180 10,525,223 8/19/09 -- (117,944) Norwegian Krone ..... BBU Sell 387,282 60,000 8/19/09 -- (124) Norwegian Krone ..... HAND Buy 1,247,141 190,000 8/19/09 3,613 -- Norwegian Krone ..... DBFX Sell 386,400 60,000 8/19/09 13 -- Euro ................ SSBT Sell 6,276,055 8,403,174 8/31/09 -- (398,981) Euro ................ BANT Sell 2,425,000 3,270,379 8/31/09 -- (130,679) Euro ................ HSBC Sell 2,060,000 2,775,926 8/31/09 -- (113,220) Euro ................ BBU Sell 1,740,000 2,403,816 8/31/09 -- (36,531) Euro ................ DBFX Sell 420,000 600,831 8/31/09 11,782 -- New Zealand Dollar .. BANT Sell 6,574,477 3,480,014 9/10/09 -- (741,507) New Zealand Dollar .. SSBT Sell 331,000 187,391 9/10/09 -- (25,147) New Zealand Dollar .. HSBC Sell 320,000 193,526 9/10/09 -- (11,948) New Zealand Dollar .. BANT Buy 1,822,500 938,479 9/10/09 231,762 -- New Zealand Dollar .. SSBT Buy 977,100 485,944 9/10/09 141,459 -- British Pound ....... BANT Sell 650,000 935,467 9/14/09 -- (133,868) Euro ................ BBU Sell 6,000,000 8,165,610 9/14/09 -- (248,788) Euro ................ BANT Sell 650,000 834,670 9/14/09 -- (76,890) Euro ................ SSBT Sell 594,255 776,651 9/14/09 -- (56,732) Euro ................ HSBC Sell 290,000 373,752 9/14/09 -- (32,944) Euro ................ BBU Buy 1,000,000 1,377,575 9/14/09 24,825 -- Euro ................ BANT Buy 800,000 1,102,904 9/14/09 19,016 -- Euro ................ SSBT Buy 2,201,579 3,053,458 9/14/09 34,036 -- Euro ................ AESX Buy 200,000 275,452 9/14/09 5,028 -- Australian Dollar ... SSBT Sell 16,784,388 12,292,672 9/17/09 -- (1,141,995) Australian Dollar ... HSBC Sell 1,456,171 1,120,861 9/17/09 -- (44,697) Australian Dollar ... BANT Sell 570,438 456,876 9/17/09 -- (823) Australian Dollar ... SSBT Buy 500,000 350,845 9/17/09 49,368 -- Australian Dollar ... BANT Buy 300,000 239,940 9/17/09 188 -- Japanese Yen ........ SSBT Sell 288,021,073 2,915,193 10/20/09 -- (78,248)
24 | Semiannual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- ---------- ----------- ---------- ------------ ------------ Japanese Yen ................ BBU Sell 11,701,680 $ 120,000 10/20/09 $ -- $ (1,617) Japanese Yen ................ SSBT Buy 31,000,000 314,900 10/20/09 7,287 -- Japanese Yen ................ DBFX Sell 14,210,250 150,000 10/20/09 2,311 -- Japanese Yen ................ HSBC Sell 14,308,200 150,000 10/20/09 1,293 -- Japanese Yen ................ AESX Sell 32,582,787 340,000 10/20/09 1,363 -- Euro ........................ HSBC Sell 1,580,000 2,119,267 11/13/09 -- (96,273) Euro ........................ BBU Sell 18,000,000 25,012,800 11/30/09 -- (227,114) Euro ........................ BONY Sell 4,281,034 5,942,503 11/30/09 -- (60,437) Euro ........................ SSBT Sell 387,484 537,754 11/30/09 -- (5,583) ---------- ---------- Unrealized appreciation (depreciation) ........ 1,841,043 (7,162,650) ---------- ---------- Net unrealized appreciation (depreciation) ..... $(5,321,607) ===========
See Abbreviations on page 45. The accompanying notes are an integral part of these financial statements. Semiannual Report | 25 Mutual Financial Services Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost - Unaffiliated issuers ......................................................... $ 551,245,080 Cost - Non-controlled affiliated issuers (Note 12) .................................. 18,953,008 ------------- Total cost of investments ........................................................... $ 570,198,088 ============= Value - Unaffiliated issuers ........................................................ $ 452,727,724 Value - Non-controlled affiliated issuers (Note 12) ................................. 10,616,951 ------------- Total value of investments (includes securities loaned in the amount of $123,692) ................................................ 463,344,675 Cash ................................................................................... 34,989 Cash on deposit with brokers ........................................................... 650,917 Foreign currency, at value (cost $ 1,163,552) .......................................... 1,159,484 Receivables: Investment securities sold .......................................................... 1,443,328 Capital shares sold ................................................................. 381,180 Dividends and interest .............................................................. 2,489,744 Unrealized appreciation on forward exchange contracts .................................. 1,841,043 Other assets ........................................................................... 660 ------------- Total assets ..................................................................... 471,346,020 ------------- Liabilities: Payables: Investment securities purchased ..................................................... 9,234,134 Capital shares redeemed ............................................................. 768,036 Affiliates .......................................................................... 686,731 Securities sold short, at value (proceeds $621,027) .................................... 607,245 Payable upon return of securities loaned ............................................... 115,873 Unrealized depreciation on forward exchange contracts .................................. 7,162,650 Accrued expenses and other liabilities ................................................. 248,183 ------------- Total liabilities ................................................................ 18,822,852 ------------- Net assets, at value .......................................................... $ 452,523,168 ============= Net assets consist of: Paid-in capital ........................................................................ $ 748,221,091 Undistributed net investment income .................................................... 662,480 Net unrealized appreciation (depreciation) ............................................. (112,136,695) Accumulated net realized gain (loss) ................................................... (184,223,708) ------------- Net assets, at value .......................................................... $ 452,523,168 =============
The accompanying notes are an integral part of these financial statements. 26 | Semiannual Report Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value .................................. $ 90,299,413 ------------ Shares outstanding .................................... 8,054,429 ------------ Net asset value and maximum offering price per share .. $ 11.21 ------------ CLASS A: Net assets, at value .................................. $252,688,132 ------------ Shares outstanding .................................... 22,513,085 ------------ Net asset value per share(a) .......................... $ 11.22 ------------ Maximum offering price per share (net asset value per share / 94.25%) .......................... $ 11.90 ------------ CLASS B: Net assets, at value .................................. $ 11,116,723 ------------ Shares outstanding .................................... 1,014,809 ------------ Net asset value and maximum offering price per share(a) ........................................... $ 10.95 ------------ CLASS C: Net assets, at value .................................. $ 98,418,900 ------------ Shares outstanding .................................... 8,828,489 ------------ Net asset value and maximum offering price per share(a) ....................................... $ 11.15 ------------
(a) Redemption price is equal to net asset value less contingent deferred sales, if applicable. The accompanying notes are an integral part of these financial statements. Semiannual Report | 27 Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the six months ended June 30, 2009 (unaudited) Investment income: Dividends: (net of foreign taxes of $482,575) Unaffiliated issuers ............................................ $ 4,152,505 Non-controlled affiliated issuers ............................... 1,384,952 Interest ........................................................... 1,155,072 Reserve for uncollectible interest (Note 8) ........................ (3,809,903) Income from securities loaned ...................................... 7,116 ------------ Total investment income ...................................... 2,889,742 ------------ Expenses: Management fees (Note 3a) .......................................... 1,713,276 Administrative fees (Note 3b) ...................................... 163,999 Distribution fees: (Note 3c) Class A ......................................................... 332,000 Class B ......................................................... 56,396 Class C ......................................................... 468,367 Transfer agent fees (Note 3e) ...................................... 601,857 Custodian fees (Note 4) ............................................ 39,126 Reports to shareholders ............................................ 48,556 Registration and filing fees ....................................... 43,704 Professional fees .................................................. 72,741 Trustees' fees and expenses ........................................ 9,577 Dividends on securities sold short ................................. 22,454 Other .............................................................. 16,703 ------------ Total expenses ............................................... 3,588,756 Expense reductions (Note 4) .................................. (14,605) ------------ Net expenses .............................................. 3,574,151 ------------ Net investment income (loss) ........................... (684,409) ------------ Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ..................................................... (27,056,977) Written options ................................................. 77,594 Foreign currency transactions ................................... 9,529,462 Securities sold short ........................................... (2,685,738) ------------ Net realized gain (loss) ............................... (20,135,659) ------------ Net change in unrealized appreciation (depreciation) on: Investments ..................................................... 48,043,285 Translation of other assets and liabilities denominated in foreign currencies ............................ (14,611,182) ------------ Net change in unrealized appreciation (depreciation) ... 33,432,103 ------------ Net realized and unrealized gain (loss) ............................... 13,296,444 ------------ Net increase (decrease) in net assets resulting from operations ....... $ 12,612,035 ============
The accompanying notes are an integral part of these financial statements. 28 | Semiannual Report Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED JUNE 30, 2009 YEAR ENDED (UNAUDITED) DECEMBER 31, 2008 ---------------- ----------------- Increase (decrease) in net assets: Operations: Net investment income (loss) .................................. $ (684,409) $ 18,006,291 Net realized gain (loss) from investments, written options, securities sold short and foreign currency transactions .... (20,135,659) (165,287,534) Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies .............. 33,432,103 (195,132,628) ------------ ------------- Net increase (decrease) in net assets resulting from operations ...................................... 12,612,035 (342,413,871) ------------ ------------- Distributions to shareholders from: Net investment income: Class Z .................................................... -- (3,377,037) Class A .................................................... -- (8,457,768) Class B .................................................... -- (299,698) Class C .................................................... -- (2,396,773) ------------ ------------- Total distributions to shareholders .............................. -- (14,531,276) ------------ ------------- Capital share transactions: (Note 2) Class Z .................................................... (4,479,706) (3,195,319) Class A .................................................... (14,782,164) 15,415,528 Class B .................................................... (2,302,188) (6,375,808) Class C .................................................... (7,388,437) (554,166) ------------ ------------- Total capital share transactions ................................. (28,952,495) 5,290,235 ------------ ------------- Redemption fees .................................................. -- 9,462 ------------ ------------- Net increase (decrease) in net assets ................... (16,340,460) (351,645,450) Net assets: Beginning of period .............................................. 468,863,628 820,509,078 ------------ ------------- End of period .................................................... $452,523,168 $ 468,863,628 ------------ ------------- Undistributed net investment income included in net assets: End of period .................................................... $ 662,480 $ 1,346,889 ============ =============
The accompanying notes are an integral part of these financial statements. Semiannual Report | 29 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual Financial Services Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Investments in non-registered money market funds are valued at the closing net asset value. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the 30 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the Semiannual Report | 31 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. The Fund purchases or writes option contracts in order to manage equity price risk. An option is a contract entitling the holder to purchase or sell a specific amount of shares or units of a particular security, currency or index at a specified price. Options purchased are recorded as an asset while options written are recorded as a liability. Upon exercise of an option, the acquisition cost or sales proceeds of the security is adjusted by any premium paid or received. Upon expiration of an option, any premium paid or received is recorded as a realized loss or gain. Upon closing an option other than through expiration or exercise, the difference between the premium and the cost to close the position is recorded as a realized gain or loss. See Note 11 regarding other derivative information. D. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. E. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund incurs a loss if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 32 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. SECURITIES SOLD SHORT (CONTINUED) The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the fund must maintain a deposit with broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. F. SPECIAL PURPOSE ENTITIES At June 30, 2009, the Fund contributed an additional $1,709,535 as a subordinated note holder of certain special purpose entities ("SPEs"). Such contributions, while made at the discretion of the Fund, represent additional capital contributions to the SPE in support of its underlying investments and are subject first to the claims of the senior note holders of the SPE. These contributions are recorded as an addition to the Fund's cost basis in the SPE and are subject to the risk of loss in the event of continued unfavorable market conditions related to the SPE's underlying investments. G. SECURITIES LENDING The Fund participates in an agency based security lending program. The Fund receives cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. The collateral is invested in a non-registered money market Fund managed by the Fund's custodian on the Fund's behalf. The Fund receives income from the investment of cash collateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the market risk with respect to the collateral investment, securities loaned, and the risk that the agent may default on its obligations to the Fund. The securities lending agent has agreed to indemnify the Fund in the event of default by a third party borrower. H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax positions, taken on federal income tax returns, for each of the three open tax years and as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Semiannual Report | 33 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME TAXES (CONTINUED) Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. 34 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. REDEMPTION FEES A short term trading redemption fee was imposed, with some exceptions, on any fund shares that were redeemed or exchanged within seven calendar days following their purchase date. The redemption fee was 2% of the amount redeemed. Such fees were retained by the fund and accounted for as an addition to paid-in capital. Effective September 1, 2008, the redemption fee was eliminated. L. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ------------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT ---------- ------------ ----------- ------------- CLASS Z SHARES Shares sold ................................................ 449,731 $ 4,681,465 1,804,326 $ 26,949,928 Shares issued in reinvestment of distributions ............. -- -- 277,927 3,087,103 Shares redeemed ............................................ (882,420) (9,161,171) (2,423,622) (33,232,350) ---------- ------------ ----------- ------------- Net increase (decrease) .................................... (432,689) $ (4,479,706) (341,369) $ (3,195,319) ========== ============ =========== ============= CLASS A SHARES: Shares sold ................................................ 2,810,971 $ 29,451,464 12,037,190 $ 182,417,278 Shares issued in reinvestment of distributions ............. -- -- 681,749 7,602,265 Shares redeemed ............................................ (4,346,497) (44,233,628) (12,261,409) (174,604,015) ---------- ------------ ----------- ------------- Net increase (decrease) .................................... (1,535,526) $(14,782,164) 457,530 $ 15,415,528 ========== ============ =========== ============= CLASS B SHARES: Shares sold ................................................ 36,890 $ 359,810 154,390 $ 2,269,646 Shares issued in reinvestment of distributions ............. -- -- 24,414 267,402 Shares redeemed ............................................ (264,833) (2,661,998) (619,982) (8,912,856) ---------- ------------ ----------- ------------- Net increase (decrease) .................................... (227,943) $ (2,302,188) (441,178) $ (6,375,808) ========== ============ =========== =============
Semiannual Report | 35 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST (CONTINUED)
SIX MONTHS ENDED YEAR ENDED JUNE 30, 2009 DECEMBER 31, 2008 ------------------------- ------------------------- SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------ CLASS C SHARES: Shares sold ........................................ 634,391 $ 6,648,484 3,312,956 $ 50,459,766 Shares issued in reinvestment of distributions ..... -- -- 192,049 2,143,797 Shares redeemed .................................... (1,393,164) (14,036,921) (3,795,954) (53,157,729) ---------- ------------ ---------- ------------ Net increase (decrease) ............................ (758,773) $ (7,388,437) (290,949) $ (554,166) ========== ============ ========== ============
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
ANNUALIZED FEE RATE NET ASSETS - ---------- ----------------------------------------------- 0.800% Up to and including $1 billion 0.770% Over $1 billion, up to and including $2 billion 0.750% Over $2 billion, up to and including $5 billion 0.730% In excess of $5 billion
B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ---------- --------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $1.2 billion
36 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ............................................ 0.35% Class B ............................................ 1.00% Class C ............................................ 1.00%
Effective February 1, 2009, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................. $55,115 Contingent deferred sales charges retained ...... $11,766
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $601,857, of which $432,146 was retained by Investor Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, the custodian fees were reduced as noted in the Statement of Operations. Semiannual Report | 37 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 5. INDEPENDENT TRUSTEES RETIREMENT PLAN On January 1, 1993, the Trust adopted an Independent Trustees' Retirement Plan ("Plan"). The Plan is an unfunded defined benefit plan that provides benefit payments to Trustees whose length of service and retirement age meets the eligibility requirements of the Plan. Benefits under the Plan are based on years of service and fees paid to each trustee at the time of retirement. Effective in December 1996, the Plan was closed to new participants. During the period ended June 30, 2009, the Fund's projected benefit obligation and benefit payments under the Plan were as follows: (a) Projected benefit obligation at June 30, 2009 .. $17,598 (b) Increase in projected benefit obligation .... .. $ 744 Benefit payments made to retired trustees .......... $ 365
(a) The projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities. (b) The increase in projected benefit obligation is included in trustees' fees and expenses in the Statement of Operations. 6. INCOME TAXES For tax purposes, capital losses may be carried over to offset future capital gains, if any. At December 31, 2008, the Fund had tax basis capital losses of $105,853,047 expiring in 2016. For tax purposes, realized capital losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2008, the Fund deferred realized capital losses of $35,488,912. At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ............................. $ 583,163,559 ============= Unrealized appreciation ......................... $ 31,530,176 Unrealized depreciation ......................... (151,349,060) ------------- Net unrealized appreciation (depreciation) ...... $(119,818,884) =============
Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of foreign currency transactions, passive foreign investment company shares, pass-through entity income, and certain dividends on securities sold short. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, passive foreign investment company shares, pass-through entity income, and certain dividend on securities sold short. 38 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 7. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the period ended June 30, 2009, aggregated $136,763,905 and $105,991,669, respectively. Transactions in options written during the period ended June 30, 2009, were as follows:
NUMBER OF PREMIUMS CONTRACTS RECEIVED --------- -------- Options outstanding at December 31, 2008 ... 113 $ 77,594 Options written ............................ -- -- Options expired ............................ (113) (77,594) Options exercised .......................... -- -- Options closed ............................. -- -- ---- -------- Options outstanding at June 30, 2009 ....... -- $ -- ==== ========
8. CREDIT RISK AND DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. If it becomes probable that income on debt securities, including those of distressed companies, will not be collected, the Fund discontinues accruing income and recognizes a reserve for uncollectible interest. At June 30, 2009, the aggregate value of distressed company securities and securities for which interest has been discontinued was $1,413,138, representing 0.31% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. Semiannual Report | 39 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED) At June 30, 2009, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Trustees as reflecting fair value, as follows:
PRINCIPAL AMOUNT/ ACQUISITION SHARES ISSUER DATES COST VALUE - ----------------- -------------------------------------------------------- ------------------ ----------- ----------- 350,000 Atlantic Banc Holdings Inc. ............................ 2/01/07 $ 3,500,000 $ 2,279,763 456,903 The Bankshares Inc. .................................... 3/22/07 4,569,030 1,737,999 1,139,363 Cerberus CG Investor I LLC ............................. 7/26/07 - 6/17/08 1,135,461 216,479 1,000,000 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............ 7/26/07 1,000,000 190,000 1,139,363 Cerberus CG Investor II LLC ............................ 7/26/07 - 6/17/08 1,135,461 216,479 1,000,000 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ........... 7/26/07 1,000,000 190,000 569,682 Cerberus CG Investor III LLC ........................... 7/26/07 - 6/17/08 567,731 108,239 500,000 Cerberus CG Investor III LLC, 12.00%, 7/31/14 .......... 7/26/07 500,000 95,000 4,357,178 Cerberus FIM Investors Holdco LLC ...................... 11/20/06 - 6/02/09 4,357,178 317,203 12,895,188 Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 .... 11/21/06 12,895,188 938,138 5,268 Elephant Capital Holdings Ltd. ......................... 8/29/03 - 3/10/08 612,722 -- 496,868 First Chicago Bancorp .................................. 11/16/06 6,956,152 1,253,161 2,339,859 Hightower Holding LLC, pfd ............................. 3/31/08 - 3/05/09 2,339,859 1,899,263 551,589 Imagine Group Holdings Ltd. ............................ 8/31/04 5,649,099 5,024,810 25,741 NCB Warrant Holdings Ltd., A ........................... 12/16/05 - 3/10/08 271,013 -- 7,480 Olympus Re Holdings Ltd. ............................... 12/19/01 723,329 16,347 2,714,922 Pontus I LLC, junior note, 144A, FRN, 4.856%, 7/24/09 .. 1/22/08 - 2/25/08 3,777,689 2,605,112 430,639 Pontus II Trust, junior profit-participating note, 144A, FRN, 7.66%, 6/25/09 ................................. 2/29/08 1,077,409 750,208 96,850 Star Asia Finance Ltd., 144A ........................... 2/22/07 - 5/18/07 9,836,925 199,036 1,020,510 Symetra Financial ...................................... 7/27/04 11,730,000 14,960,677 ----------- TOTAL RESTRICTED SECURITIES (7.29% of Net Assets) ...... $32,997,914 ===========
10. UNFUNDED CAPITAL COMMITMENTS The Fund may enter into certain capital commitments and may be obligated to perform on such agreements at a future date. Unfunded capital commitments requiring recognition are monitored for impairment and any unrealized deprecation is included in the Statement of Assets and Liabilities and the Statement of Operations. At June 30, 2009, the Fund had aggregate unfunded capital commitments of $1,061,732, for which no depreciation has been recognized. 40 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 11. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS ASSET DERIVATIVES LIABILITY DERIVATIVES HEDGING INSTRUMENTS ---------------------------------------- ------------------------------------------- UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ----------- -------------------------- -------------- Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $1,841,043 forward exchange contracts $7,162,650
For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- --------------------------------------------- -------------- -------------- ----------- Foreign exchange contracts ....... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $10,805,087 $(14,213,665) 187,494,832 Equity contracts ... Net realized gain (loss) from written options/Net change in unrealized appreciation (depreciation) on investments 77,594 (58,949) 49
(a) Represents the average number of option contracts or notional amount for other derivative contracts outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(c) regarding derivative financial instruments. Semiannual Report | 41 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 12. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund for the period ended June 30, 2009, were as shown below.
NUMBER OF NUMBER OF SHARES SHARES VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF PERIOD ADDITIONS REDUCTIONS OF PERIOD PERIOD INCOME GAIN (LOSS) - -------------- ----------------- --------- ---------- ----------- ----------- ---------- ----------- NON-CONTROLLED AFFILIATES AB&T Financial Corp ......... 226,100 -- -- 226,100 $ 1,045,713 $ -- $-- Atlantic Banc Holdings Inc .. 350,000 -- -- 350,000 2,279,763 -- -- First Clover Leaf Financial Corp ........... 436,070 -- -- 436,070 3,096,097 52,328 -- Protector Forsikring ASA .... 4,479,410 -- -- 4,479,410 4,195,378 1,332,624 -- ----------- ---------- --- TOTAL AFFILIATED SECURITIES (2.35% of Net Assets) ........ $10,616,951 $1,384,952 $-- =========== ========== ===
13. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Franklin Mutual serves as investment manager to certain special purpose entities that issue securities held by the Fund. Franklin Mutual is not compensated for such services and does not invest in or exercise control over such entities. As investment manager, Franklin Mutual is primarily responsible for recommending investments in unaffiliated issuers to be held by the special purpose entities. Securities issued by these special purpose entities are restricted under the Securities Act of 1933 and are deemed to be illiquid. 14. CREDIT FACILITY Effective January 23, 2009, the Fund, together with other U.S. registered and foreign investment funds managed by Franklin Templeton Investments (individually, "Borrower"; collectively "Borrowers"), entered into a joint syndicated senior unsecured credit facility totaling $725 million (Global Credit Facility) to provide a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests. 42 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 14. CREDIT FACILITY (CONTINUED) Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee based upon the unused portion of the Global Credit Facility. During the period, the Fund incurred commitment fees of $1,477 of its pro rata portion of the Global Credit Facility, which is reflected in other expenses on the Statements of Operations. During the period ended June 30, 2009, the Fund did not utilize the Global Credit Facility. 15. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used as of June 30, 2009, in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL ------------ ------------ ------------ ------------ ASSETS: Investments in Securities: Equity Investments:(a) Commercial Banks ............................. $ 54,517,073 $ -- $ 5,270,923 $ 59,787,996 Commercial Services & Supplies ............... 1,586,633 -- --(b) 1,586,633 Consumer Finance ............................. 1,611,351 -- 858,400 2,469,751 Diversified Financial Services ............... 58,065,264 -- 1,899,263 59,964,527 Insurance .................................... 132,876,444 -- 20,001,834 152,878,278 Real Estate Management & Development ......... 8,146,266 -- 199,036 8,345,302 All other Equity Investments(c) .............. 57,492,344 -- -- 57,492,344 Corporate Bonds & Notes ......................... -- 18,175,300 6,969,056 25,144,356 Short Term Investments .......................... 91,960,775 3,714,713 -- 95,675,488 ------------ ----------- ------------ ------------ Total Investments in Securities ................. $406,256,150 $21,890,013 $ 35,198,512 $463,344,675 ============ =========== ============ ============ Forward Exchange Contracts ............................ $ -- $ 1,841,043 $ -- $ 1,841,043
Semiannual Report | 43 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 15. FAIR VALUE MEASUREMENTS (CONTINUED)
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL --------- ---------- ------- ---------- LIABILITIES: Securities Sold Short ........................ $607,245 $ -- $-- $ 607,245 Forward Exchange Contracts ................... -- 7,162,650 -- 7,162,650
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. (c) For detailed industry descriptions, see the accompanying Statement of Investments. At June 30, 2009, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:
NET CHANGE IN UNREALIZED NET CHANGE APPRECIATION IN (DEPRECIATION) NET UNREALIZED NET TRANSFER ATTRIBUTABLE TO BEGINNING REALIZED APPRECIATION PURCHASES IN (OUT) ENDING ASSETS STILL HELD BALANCE GAIN (LOSS) (DEPRECIATION) (SALES) OF LEVEL 3 BALANCE AT PERIOD END ----------- ----------- -------------- ---------- ---------- ----------- ----------------- ASSETS Investments in Securities: Equity Securities:(a) Commercial Banks ......... $10,280,144 $ -- $(5,009,221) $ -- $-- $ 5,270,923 $(5,009,221) Commercial Services & Supplies .............. -- -- -- -- -- --(b) -- Consumer Finance ......... 1,480,253 -- (670,026) 48,173 -- 858,400 (670,026) Diversified Financial Services .............. 855,396 (2,109,777) 2,962,370 191,274 -- 1,899,263 2,962,370 Insurance ................ 18,097,652 -- 1,904,182 -- -- 20,001,834 1,904,182 Real Estate Management & Development ........... 413,550 -- (214,514) -- -- 199,036 (214,514) Corporate Bonds & Notes .. 6,410,912 -- (1,215,967) 1,774,111 -- 6,969,056 (1,215,967) ----------- ----------- ----------- ---------- --- ----------- ----------- Total Investments in Securities ............ $37,537,907 $(2,109,777) $(2,243,176) $2,013,558 $-- $35,198,512 $(2,243,176) =========== =========== =========== ========== === =========== ===========
(a) Includes common and preferred stocks as well as other equity investments. (b) Includes securities determined to have no value at June 30, 2009. 16. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 14, 2009 and determined that no events have occurred that require disclosure. 44 | Semiannual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) ABBREVIATIONS CURRENCY EUR - Euro GBP - British Pound SELECTED PORTFOLIO ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note REIT - Real Estate Investment Trust COUNTERPARTY AESX - Credit Suisse International BANT - Bank of America N.A. BBU - Barclays Bank BONY - Bank of New York Mellon DBFX - Deutsche Bank AG HAND - Svenska Handelsbanken HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 45 Mutual Financial Services Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved renewal of the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such renewals, the independent trustees held three meetings dedicated to the renewal process (those trustees unable to attend in person were present by telephonic conference means). Throughout the process, the independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager (including portfolio managers), the transfer agent and shareholder services group and the distributor. In approving the renewal of the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the existing investment management fee structure was fair and reasonable and that continuance of the agreements was in the best interests of the Fund and its shareholders. In reaching their decision on the investment management agreement (as well as the administrative services agreement), the trustees took into account information furnished throughout the year at regular Board meetings, as well as information specifically requested and furnished for the renewal process, which culminated in the meetings referred to above for the specific purpose of considering such agreements. Information furnished throughout the year included, among others, reports on the Fund's investment performance, expenses, portfolio composition, portfolio brokerage execution, soft dollars/client commission arrangements, derivatives, securities lending, portfolio turnover, Rule 12b-1 plans, distribution, shareholder servicing, compliance, pricing of securities and sales and redemptions, along with related financial statements and other information about the scope and quality of services provided by the investment manager and its affiliates and enhancements to such services over the past year. Such material also addressed some of the actions taken by management in responding to turmoil in the markets in the past year. In addition, the trustees received periodic reports throughout the year and during the renewal process relating to compliance with the Fund's investment policies and restrictions. During the renewal process, the independent trustees considered the investment manager's methods of operation within the Franklin Templeton group and its activities on behalf of other clients. The information obtained by the trustees during the renewal process also included a special report prepared by Lipper, Inc. (Lipper), an independent third-party analyst, comparing the Fund's investment performance and expenses with those of other mutual funds deemed comparable to the Fund as selected by Lipper (Lipper Section 15(c) Report). The trustees reviewed the Lipper Section 15(c) Report and its usefulness in the renewal process with respect to matters such as comparative fees, expenses, expense ratios, performance and volatility. While noting some limitations of the Lipper Section 15(c) Report (as more fully discussed below under "Comparative Expenses and Management Profitability"), they concluded that the report continues to be a reliable resource in the performance of their duties. 46 | Semiannual Report Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In addition, the trustees received and reviewed a report on the investment manager's (and its parent's) profitability (Profitability Study). Over the past year, the Board and counsel to the independent trustees continued to receive reports on management's handling of recent regulatory actions and pending legal actions against the investment manager and its affiliates. The independent trustees were satisfied with the actions taken to date by management in response to such regulatory and legal proceedings. Particular attention was given to the overall performance and actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counter-party credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, management's efforts in establishing a $725 million global credit facility for the benefit of the Fund and other accounts managed by Franklin Resources, Inc., to provide a source of cash for temporary and emergency purposes or to meet unexpected redemption requests as well as the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions, and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services being provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services provided by the investment manager. In this regard, they reviewed the Fund's investment approach and concluded that, in their view, it continues to differentiate the Fund from typical core investment products in the mutual fund field. The trustees cited the investment manager's ability to implement the Fund's disciplined value investment approach and its long-term relationship with the Fund as reasons that shareholders choose to invest, and remain invested, in the Fund. The trustees reviewed the Fund's portfolio management team, including its performance, Semiannual Report | 47 Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) staffing, skills and compensation program. With respect to portfolio manager compensation, management assured the trustees that the Fund's long-term performance is a significant component of incentive-based compensation and noted that a portion of a portfolio manager's incentive-based compensation is paid in shares of predesignated funds from the portfolio manager's fund management area. The trustees noted that the portfolio manager compensation program aligned the interests of the portfolio managers with that of Fund shareholders. The trustees discussed with management various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. During regular Board meetings and the aforementioned meetings of the independent trustees, the trustees received reports and presentations on the investment manager's best execution trading policies. The trustees considered periodic reports provided to them showing that the investment manager complied with the investment policies and restrictions of the Fund as well as other reports periodically furnished to the Board covering matters such as the compliance of portfolio managers and other management personnel with the code of ethics covering the investment management personnel, the adherence to fair value pricing procedures established by the Board and the accuracy of net asset value calculations. The Board noted the extent of the benefits provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also reviewed the nature, extent and quality of the Fund's other service agreements to determine that, on an overall basis, Fund shareholders were well served. In this connection, the Board also took into account administrative and transfer agent and shareholder services provided to Fund shareholders by an affiliate of the investment manager, noting continuing expenditures by management to increase and improve the scope of such services and favorable periodic reports on shareholder services conducted by independent third parties. While such considerations directly affected the trustees' decision in renewing the Fund's administrative services and transfer agent and shareholder services agreement, the Board also considered these commitments as incidental benefits to Fund shareholders deriving from the investment management relationship. Based on their review, the trustees were satisfied with the nature and quality of the overall services provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to continue the disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The trustees reviewed and placed significant emphasis on the investment performance of the Fund over the one-, three-, five- and 10-year periods ended December 31, 2008. They considered the history of successful performance of the Fund relative to various benchmarks. As part of their review, they inquired of management regarding benchmarks, style drift and restrictions on permitted investments. Consideration was also given to performance in the context of available levels of cash during the periods. The trustees had meetings during the 48 | Semiannual Report Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) year, including the meetings referred to above held in connection with the renewal process, with the Fund's portfolio managers to discuss performance and the management of the Fund through the market turmoil and financial crisis. In these meetings, the trustees discussed the losses experienced by the Fund over the past year and the reasons therefor. In addition, particular attention in assessing performance was given to the Lipper Section 15(c) Report. That report showed the investment performance of the Fund (Class A shares) in comparison to other funds determined comparable by Lipper. The comparable funds to the Fund, as chosen by Lipper, included all retail and institutional global financial services funds. Consistent with the market sell-off that occurred during the past year, the Fund and all of the comparable funds chosen by Lipper experienced losses during such period. The Fund had total returns in the best performing quintile for the one-year period ended December 31, 2008, and had annualized total returns for the three- and five-year periods in the best and second-best performing quintiles, respectively. The trustees noted that the Fund's total return on an annualized basis for the 10-year period ended December 31, 2008, was in the best performing quin-tile and exceeded 5%, as shown in the Lipper Section 15(c) Report. The Board was satisfied with such comparative performance. The trustees also compared Fund performance to other industry benchmarks, including measures of risk-adjusted performance of a fund, as part of their evaluation of investment performance. According to the Lipper Section 15(c) Report, the Fund's risk-adjusted performance was in Lipper's lowest, middle and best performing quintiles of peer funds for the three-, five- and 10-year periods ended December 31, 2008, respectively. The trustees concluded that, while the Fund's losses during the past year were disappointing, the Fund had continued to perform well in comparison to its various benchmarks and in the context of the Fund's objectives. COMPARATIVE EXPENSES AND MANAGEMENT PROFITABILITY. The trustees considered the cost of the services provided and to be provided and the profits realized by the investment manager and its affiliates from their respective relationships with the Fund. As part of the approval process, they explored with management the trends in expense ratios over the past three fiscal years and the reasons for any increases in the Fund's expense ratios. In considering the appropriateness of the management fee and other expenses charged the Fund, the Board took into account various factors including investment performance and matters relating to Fund operations, including, but not limited to, the quality and experience of its portfolio managers and research staff. Consideration was also given to a comparative analysis in the Lipper Section 15(c) Report of the investment management fee and total expense ratios of the Fund in comparison with those of a group of other funds selected by Lipper as its appropriate Lipper expense group. Lipper expense data is based upon historical information taken from each fund's most recent annual report and, as a result of the severe decline in mutual fund industry assets during the last quarter of 2008, is based on asset levels that are higher than the level currently existing for most funds. While recognizing the limitations inherent in Lipper's methodology and recognizing that current expense ratios may Semiannual Report | 49 Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) increase as assets decline, the Board believed that the independent analysis conducted by Lipper remained an appropriate measure of comparative expenses. In reviewing comparative costs, emphasis was given to the Fund's contractual management fee in comparison with the contractual management fee that would have been charged by other funds within its Lipper expense group assuming they were similar in size to the Fund, as well as the actual total expenses of the Fund in comparison with those of its Lipper expense group. The Lipper contractual management fee analysis includes administrative charges as being part of the management fee, and total expenses, for comparative consistency, are shown by Lipper for Fund Class A shares. The Fund's contractual management fee rate was in the second most expensive quintile of its Lipper expense group and its total expenses were in the middle quintile of such group. The Board was satisfied with such comparative expenses, noting that the Fund's contractual management fee rate was within 8 basis points of its Lipper expense group median. The trustees also reviewed the Profitability Study addressing profitability of Franklin Resources, Inc., from its overall U.S. fund business, as well as profitability of the investment manager to the Fund, from providing investment management and other services to the Fund during the 12-month period ended September 30, 2008, the most recent fiscal year end of Franklin Resources, Inc. During such period, the assets of the Franklin Templeton U.S. fund business were significantly higher than currently existing, and to such extent the profitability analysis does not reflect current fund operations. While taking into account in assessing the significance of the Profitability Study, the Board recognized the Profitability Study was made at a given point in time and that the decline in assets and effect on profitability would be reflected in the profitability study covering Franklin Resources, Inc.'s 2009 fiscal year period. The trustees noted that this analysis is reviewed every other year by independent accountants based on agreed-upon methodologies. The trustees reviewed the basis on which such reports are prepared and the reasonableness of the cost allocation methodology utilized in the Profitability Study, it being recognized that allocation methodologies may each be reasonable while producing different results. The independent trustees reviewed the investment manager's method of assignment and allocation of actual expenses to the Fund, allocations for other accounts managed by the investment manager and the method of allocations in the Profitability Study. The independent trustees met with management to discuss the Profitability Study. This included, among other things, a comparison of investment management income with investment management expenses of the Fund; comparison of underwriting revenues and expenses; the relative relationship of investment management and underwriting expenses; shareholder servicing profitability (losses); economies of scale; and the relative contribution of the Fund to the profitability of the investment manager and its parent. In discussing the Profitability Study with the Board, the investment manager stated its belief that the costs incurred in establishing the infrastructure necessary to operate the type of mutual fund operations conducted by it and its affiliates may not be fully reflected in the expenses allocated to the Fund in determining its profitability. 50 | Semiannual Report Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) The trustees considered an additional Lipper study analyzing the profitability of the parent of the investment manager as compared to other publicly held investment managers, which also aided the trustees in considering profitability outside the context of distribution. The Board also took into account management's expenditures in improving shareholder services provided to the Funds, as well as the need to meet additional regulatory and compliance requirements resulting from the Sarbanes-Oxley Act and recent SEC and other regulatory requirements. The trustees also considered the extent to which the investment manager may derive ancillary benefits from Fund operations, including those derived from economies of scale, discussed below, the allocation of Fund brokerage and the use of commission dollars to pay for research and other similar services. The Board noted the interest an affiliate of the investment manager has in a joint venture that financed up-front commissions paid to brokers/dealers who sold Fund Class B shares, noting that the Fund has ceased offering Class B shares and the benefits derived from the Fund as a result of this arrangement will diminish over time. Based upon their consideration of all these factors, the trustees determined that the level of profits realized by the manager and its affiliates in providing services to the Fund was not excessive in view of the nature, quality and extent of services provided. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. While recognizing that any precise determination is inherently subjective, the trustees noted that, based upon the Profitability Study, as some funds increase in size, at some point economies of scale may result in the investment manager realizing a larger profit margin on investment management services provided such a fund. The trustees also noted that benefits of economies of scale will be shared with Fund shareholders due to the decline in the effective investment management fee rate as breakpoints are achieved by the Fund. The trustees noted that breakpoints have been instituted as part of the Fund's investment management fee in 2004. The trustees assessed the breakpoints and believed they were, and continue to be, appropriate and they agreed to continue to monitor the appropriateness of the breakpoints. The trustees also considered the effects an increase in assets under management would have on the investment management fee of the Fund. To the extent further economies of scale may be realized by the investment manager and its affiliates, the Board believed the investment management and administrative fees provide a sharing of benefits with the Fund and its shareholders. Semiannual Report | 51 Mutual Financial Services Fund SHAREHOLDER INFORMATION (CONTINUED) PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. 52 | Semiannual Report Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS (R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL FINANCIAL SERVICES FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, B & C) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 479 S2009 08/09 JUNE 30, 2009 SEMIANNUAL REPORT AND SHAREHOLDER LETTER SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" (GRAPHIC) INTERNATIONAL MUTUAL INTERNATIONAL FUND (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) Franklin - Templeton - MUTUAL SERIES Franklin Templeton Investments GAIN FROM OUR PERSPECTIVE(R) Franklin Templeton's distinct multi-manager structure combines the specialized expertise of three world-class investment management groups-- Franklin, Templeton and Mutual Series. SPECIALIZED EXPERTISE Each of our portfolio management groups operates autonomously, relying on its own research and staying true to the unique investment disciplines that underlie its success. FRANKLIN. Founded in 1947, Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. TEMPLETON. Founded in 1940, Templeton pioneered international investing and, in 1954, launched what has become the industry's oldest global fund. Today, with offices in over 25 countries, Templeton offers investors a truly global perspective. MUTUAL SERIES. Founded in 1949, Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among what it believes are undervalued stocks, as well as arbitrage situations and distressed securities. TRUE DIVERSIFICATION Because our management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why our funds can be used to build truly diversified allocation plans covering every major asset class. RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable, accurate and personal service that has helped us become one of the most trusted names in financial services.
MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS (GRPAHIC) Not part of the semiannual report Contents SHAREHOLDER LETTER ........................................................ 1 SEMIANNUAL REPORT Mutual International Fund ................................................. 4 Performance Summary ....................................................... 10 Your Fund's Expenses ...................................................... 13 Financial Highlights and Statement of Investments ......................... 15 Financial Statements ...................................................... 23 Notes to Financial Statements ............................................. 27 Shareholder Information ................................................... 36
Shareholder Letter Dear Mutual International Fund Shareholder: We are excited to present this first shareholder report to investors in our newest fund, Mutual International Fund, which launched on May 1. This fund is focused on investing outside of the U.S., primarily in developed markets in Europe and Asia. The investment philosophy of this new Fund is the same as for other Mutual Series funds -- to invest for the long term in securities that trade at a discount to intrinsic value. Like the other funds we manage, Mutual International Fund can also invest in merger and acquisition situations as well as in distressed debt instruments that we believe may generate superior risk-adjusted returns. Financial markets reached historical extremes in the first half of 2009. The global economy slowed dramatically in the fourth quarter of 2008 and continued its slide into this year. Unemployment rolls expanded, property prices continued to fall, and government bond yields declined, reflecting great skepticism about the prospects for economic recovery. Each week seemed to bring an addition to the alphabet soup of government programs in the U.S. -- TARP, TALF, PPIP -- designed to stimulate lending and stabilize the financial system. Although there were no repeats of the bankruptcies or government takeovers of the likes of Bear Stearns, Lehman Brothers, AIG or Fannie Mae, the specter of bank nationalization in the U.S. and Europe was all too real, as was the possibility of a further serious and potentially calamitous blow to the system. Investors correctly understood that banks and other large financial players needed substantial amounts of additional capital to survive -- the question was at what price and whether further government control would be necessary. NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE Not part of the semiannual report | 1 Given that the global economy's financial underpinnings weakened considerably but did not completely implode, investor sentiment switched from panic to relief during the first six months of the year. The Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East (EAFE) Index, which by March had fallen 60% from its highs in October 2007, rallied 45% to the end of the first half of 2009.(1) European equity markets were similarly volatile although they did not experience as significant a rebound since most investors believed the recovery in Europe would be slower than in the U.S. Like the U.S. Federal Reserve Board, the Bank of England was viewed as actively pursuing a policy of quantitative easing, while the European Central Bank expanded its balance sheet even more than its brethren. The story in Asia was quite different as fiscal balances of most nations in the region were in better condition. In fact, China was a significant lender to the U.S. Diversification is an attractive attribute of international investing and while we have never completely subscribed to the decoupling argument, we think it is fair to say that Asia beats to a somewhat different drum. In some respects this is not positive -- Japan's economy has been suffering for a decade and its declining population brings a whole different set of issues. However, China's emergence as a major economy continues to present opportunities for companies all over the world, particularly its trading partners in Asia. The Fund's launch in May came at an interesting time for value investors given the strong rally in equity and corporate debt markets over the prior two months. While prices were higher than they had been earlier in the year when panic ruled the marketplace, the stabilization of the financial markets made the risk-reward calculation for many companies quite attractive over the long term. We particularly like companies in defensive industries that exhibit strong cash-flow characteristics with solid balance sheets, and we were able to buy companies fitting these criteria in the consumer staples and health care sectors that had not rallied as much as some in more cyclical sectors. (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The MSCI EAFE Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets excluding the U.S. and Canada. 2 | Not part of the semiannual report While substantial uncertainties remain -- near-term ones such as the pace of economic recovery and longer term ones such as the ability of western governments to manage their enormous structural deficits and the fate of the U.S. dollar as the world's reserve currency -- we believe we are back in a "stock picker's" environment and that is where we like to be. Macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of this year. That is why we are particularly excited to be launching the Fund at this point of the cycle and hope you share our enthusiasm as well. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF JUNE 30, 2009. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the semiannual report | 3 Semiannual Report Mutual International Fund YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual International Fund seeks capital appreciation, which may occasionally be short term, with income as a secondary goal. The Fund normally invests at least 80% of its net assets in securities of non-U.S. issuers that the manager believes are available at prices less than their intrinsic value. The Fund invests, to a lesser extent, in risk arbitrage securities and distressed companies. We are pleased to bring you Mutual International Fund's inaugural semiannual report for the period from inception on May 1, 2009, through June 30, 2009. PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL (800) 342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. PERFORMANCE OVERVIEW Mutual International Fund - Class Z delivered a +5.30% cumulative total return from inception on May 1, 2009, through period-end on June 30, 2009. The Fund outperformed its benchmark, the Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East (EAFE) Index Net Return (Local Currency), which had a +4.92% total return for the same period.(1) You can find other Fund performance data in the Performance Summary beginning on page 10. ECONOMIC AND MARKET OVERVIEW During the period under review, global equities rebounded from 12-year lows reached in March and through June delivered their biggest quarterly rally in more than a decade. As data emerged suggesting a fledgling recovery in the financials sector and a moderating pace of global economic contraction, investors regained some risk appetite, rotating capital back into cyclical sectors such as financials, materials and consumer discretionary. Resurgent risk appetite also buoyed emerging markets stocks, which delivered their best three-month returns on record from March through May 2009. Emerging (1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The MSCI EAFE Index Net Return (Local Currency) is a free float-adjusted, market capitalization weighted index designed to measure equity market performance of global developed markets excluding the U.S. and Canada. The unmanaged index is calculated in local currency and includes reinvested daily net dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 19. 4 | Semiannual Report market optimism in turn supported higher commodity prices, which rallied for the first time since the bubble in hard assets burst in the summer of 2008. Also supporting commodity prices was a weaker U.S. dollar. Although systemic risk aversion and the consensus belief that the U.S. could lead the global economy out of recession helped strengthen the dollar in 2009's first quarter, investors soon began to worry about the currency's ongoing stability in the face of aggressive and unconventional monetary policy, and the greenback lost value relative to most currencies for the two-month period. In the reporting period's final weeks, equity markets moderated as investors appeared to contemplate the rally's merits and reassess their new positions. Although sentiment had improved and most seemed to believe the global economy had exited the worst stage of this recessionary cycle, indicators remained mixed and lacked the sustainable upward trajectory investors had hoped for. For example, initial U.S. jobless claims fell to their lowest levels in six months during May, but unemployment rose again at the end of the period to 9.5%.(2) In Europe, policymakers committed to an easier monetary regime, but the eurozone's industrial production declined, capacity utilization continued to shrink, and price deflation was recorded for the first time since data began in 1997.(3) In China, a stimulative monetary campaign spurred lending and fueled an annualized money growth rate of 26%, a powerful measure against near-term economic headwinds but a potentially dangerous catalyst for longer-term inflation and asset bubble formation.(4) INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks in Asia and Europe. We have the ability to invest in emerging markets, although this is unlikely to be a significant focus of our strategy. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder- oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 6/30/09 France 14.3% Germany 11.4% China 10.7% U.K. 10.5% Italy 5.4% Switzerland 5.4% Hong Kong 5.1% Australia 5.1% Ireland 4.4% Netherlands 4.3% Japan 3.4% Denmark 2.5% Belgium 2.3% Spain 2.1% South Korea 1.7% Bermuda 1.3% Other 0.9% Short-Term Investments & Other Net Assets 9.2%
(2.) Source: Bureau of Labor Statistics. (3.) Source: European Communities Eurostat. (4.) Source: People's Bank of China. Semiannual Report | 5 the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies internationally, we may invest occasionally in privately held companies as well. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 6/30/09
% OF TOTAL NET ASSETS ---------- Insurance 10.1% Food Products 8.8% Commercial Banks 7.5% Media 6.4% Food & Staples Retailing 5.9% Diversified Financial Services 4.5% Chemicals 4.3% Multi-Utilities 4.3% Hotels, Restaurants & Leisure 3.9% Industrial Conglomerates 3.2%
We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a substantial discount to face value. After the financially distressed company is reorganized, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. In addition, it is our practice to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION At period-end, Mutual International Fund was invested in 86 positions representing just over 90% of the Fund's total assets. The balance consisted of cash instruments. Of the 86 positions, 59 were in western Europe and accounted for 63.6% of total net assets; 27 positions were in Asia and accounted for 26.4% of the Fund's assets. During the two-month period since its May 1 inception, the Fund's average cash balance was 40%, a level that was consistent with our process of building the Fund's initial investment portfolio. During this shortened semiannual period, the Fund outperformed its benchmark index with the help of several investments. Three of the largest contributors during the period were CNinsure, an independent Chinese insurance agency and brokerage firm; Allied Irish Banks; and Eni, a large Italian oil, natural gas and power generation company. CNinsure operates in China where there is an emerging and growing need for insurance products as citizens acquire property and seek to protect their health or savings. While we are closely monitoring the underwriting standards in this nascent market, we invested in CNinsure partially because it holds the largest 6 | Semiannual Report agency presence in China. This helped sales increase 58% year-over-year through March 2009 with margins of more than 20%. Also, the company's balance sheet was flush with cash. In our view, CNinsure's stock was undervalued considering its growth and profitability, and we continued to hold the position at period-end. During the global banking crisis, Ireland found itself as one of the world's most challenged financial systems due to plummeting property values and serious concerns over its capital levels. The state of the Irish banking system was so severe that at one point during first quarter 2009 its total market capitalization of about E500 million was only 0.25% of the country's 2008 GDP. This was virtually unheard of in a developed market. The incredibly cheap valuation and distressed nature of these banks caught our attention and, consequently, we acquired equity as well as debt from the entire sector during the reporting period. Our foray was established on the thesis that credit losses were absorbable and government support would be adequate to ensure the system's survival. This thesis was validated as our holding in Allied Irish Banks appreciated over the reporting period and continued to trade at what we considered highly attractive valuations at period-end. The Fund's shares of Eni, Italy's largest integrated oil and gas company in which the Italian government has a 30% stake, rallied during the period, driven mostly by rising oil prices. Among the top detractors from the Fund's performance during the period were China Digital TV Holding (CDTV); A.P. Moeller-Maersk (Maersk), one of Denmark's largest industrial conglomerates with significant interests in container shipping and other types of marine transportation, oil and gas exploration and production, and food retailing; and French hotel operator Accor. CDTV provides over 50% of the conditional access cards that enable viewers to access cable TV networks through their set-top boxes in China. The stock declined on concerns about margin erosion, but with its dominant market share and economies of scale, CDTV continued to generate significant cash flow to add to its already considerable cash holdings that seemed to be ignored by the market. We believe the migration from analog to digital and the fragmented nature of the set-top box industry and cable networks in China positioned CDTV well in the content distribution channel. Our investment in Maersk stock declined on investors' concerns about the negative impact the current global economic crisis was having on world trade and, therefore, on earnings the company derives from its worldwide container shipping activities. Despite significant recessionary headwinds, at period-end we believed the market was not properly valuing Maersk's significant and diversified asset base. TOP 10 HOLDINGS 6/30/09
COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ------------------------ ---------- CNinsure Inc., ADR 1.8% INSURANCE, CHINA Intesa Sanpaolo SpA 1.8% COMMERCIAL BANKS, ITALY Nestle SA 1.5% FOOD PRODUCTS, SWITZLERLAND China Digital TV Holding Co., ADR 1.5% COMPUTERS & PERIPHERALS, CHINA Koninklijke KPN NV 1.5% DIVERSIFIED TELECOMMUNICATION SERVICES, NETHERLANDS Barclays PLC 1.5% COMMERCIAL BANKS, U.K. Fortis 1.5% DIVERSIFIED FINANCIAL SERVICES, BELGIUM Zurich Financial Services AG 1.5% INSURANCE, SWITZLERLAND Visionchina Media Inc., ADR 1.5% MEDIA, CHINA Telefonica SA 1.5% DIVERSIFIED TELECOMMUNICATION SERVICES, SPAIN
Semiannual Report | 7 Accor, which owns or manages almost 4,000 hotel properties in nearly 100 countries, is also one of the world's leading issuers of prepaid vouchers. Accor's stock price fell during the period as investors considered the global economic downturn's impact on travel and, ultimately, the company's hotel business. At period-end we believed Accor's presence, which is concentrated in the hotel sector's lower-end segment, offered it a measure of insulation during these difficult times as budget-minded travelers seek more affordable lodging. We also believed the market was not properly valuing Accor's large voucher business, which has demonstrated high, stable operating margins and cash flows. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during May and June of 2009, our hedging strategy negatively impacted performance. Thank you for your continued participation in Mutual International Fund. We look forward to serving your future investment needs. (PHOTO OF PHILIPPE BRUGERE-TRELAT) /s/ Philippe Brugere-Trelat Philippe Brugere-Trelat Co-Portfolio Manager (PHOTO OF ANDREW SLEEMAN) /s/ Andrew Sleeman Andrew Sleeman, CFA Co-Portfolio Manager Mutual International Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF JUNE 30, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. 8 | Semiannual Report PHILIPPE BRUGERE-TRELAT has been a co-portfolio manager for Mutual International Fund since its May 2009 inception. Mr. Brugere-Trelat has also served as lead portfolio manager for Mutual European Fund since 2005. He has been a member of the management team of the Mutual Series Funds since 2004, when he rejoined Franklin Templeton Investments. Previously, he was president and portfolio manager of Eurovest. Between 1984 and 1994, Mr. Brugere-Trelat was employed at Heine Securities Corporation, the Fund's former manager. ANDREW SLEEMAN has been a co-portfolio manager for Mutual International Fund since its May 2009 inception. He joined Franklin Templeton Investments in 2007. Previously, he was with Fox-Pitt, Kelton, a financials specialist firm, where he focused on international financial equities. Prior to that, he worked in international equities at BNP Paribas. He also worked in Australia in the fixed income division of JP Morgan Investment Management. Semiannual Report | 9 Performance Summary as of 6/30/09 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table does not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE INFORMATION
CLASS Z (SYMBOL: N/A) CHANGE 6/30/09 5/1/09 - --------------------- ------ ------- ------ Net Asset Value (NAV) +$0.53 $10.53 $10.00
CLASS A (SYMBOL: N/A) CHANGE 6/30/09 5/1/09 - --------------------- ------ ------- ------ Net Asset Value (NAV) +$0.53 $10.53 $10.00
CLASS C (SYMBOL: N/A) CHANGE 6/30/09 5/1/09 - --------------------- ------ ------- ------ Net Asset Value (NAV) +$0.51 $10.51 $10.00
CLASS R (SYMBOL: N/A) CHANGE 6/30/09 5/1/09 - --------------------- ------ ------- ------ Net Asset Value (NAV) +$0.53 $10.53 $10.00
10 | Semiannual Report Performance Summary (CONTINUED) PERFORMANCE(1) CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AGGREGATE TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z/R: NO SALES CHARGES; CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS C: 1% CONTINGENT DEFERRED SALES CHARGE IN FIRST YEAR ONLY.
INCEPTION CLASS Z (5/1/09) - ------- --------- Cumulative Total Return(2) +5.30% Aggregate Total Return(3) +5.30% Value of $10,000 Investment(4) $10,530 Total Annual Operating Expenses(5) Without Waiver 1.61% With Waiver 1.17%
INCEPTION CLASS A (5/1/09) - ------- --------- Cumulative Total Return(2) +5.30% Aggregate Total Return(3) -0.75% Value of $10,000 Investment(4) $9,925 Total Annual Operating Expenses(5) Without Waiver 1.91% With Waiver 1.47%
INCEPTION CLASS C (5/1/09) - ------- --------- Cumulative Total Return(2) +5.10% Aggregate Total Return(3) +4.10% Value of $10,000 Investment(4) $10,410 Total Annual Operating Expenses(5) Without Waiver 2.61% With Waiver 2.17%
INCEPTION CLASS R (5/1/09) - ------- --------- Cumulative Total Return(2) +5.30% Aggregate Total Return(3) +5.30% Value of $10,000 Investment(4) $10,530 Total Annual Operating Expenses(5) Without Waiver 2.11% With Waiver 1.67%
PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236. THE INVESTMENT MANAGER AND ADMINISTRATOR HAVE CONTRACTUALLY AGREED TO WAIVE OR LIMIT THEIR RESPECTIVE FEES AND TO ASSUME AS THEIR OWN EXPENSE CERTAIN EXPENSES OTHERWISE PAYABLE BY THE FUND SO THAT COMMON EXPENSES (I.E., A COMBINATION OF INVESTMENT MANAGEMENT FEES, FUND ADMINISTRATION FEES, AND OTHER EXPENSES, BUT EXCLUDING RULE 12B-1 FEES AND ACQUIRED FUND FEES AND EXPENSES) FOR EACH CLASS OF THE FUND DO NOT EXCEED 1.17% (OTHER THAN CERTAIN NON-ROUTINE EXPENSES OR COSTS, INCLUDING THOSE RELATING TO LITIGATION, INDEMNIFICATION, REORGANIZATIONS AND LIQUIDATIONS) UNTIL 4/30/10. Semiannual Report | 11 Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. SPECIAL RISKS ARE ASSOCIATED WITH FOREIGN INVESTING, INCLUDING CURRENCY FLUCTUATIONS, ECONOMIC INSTABILITY AND POLITICAL DEVELOPMENTS. INVESTMENTS IN EMERGING MARKETS INVOLVE HEIGHTENED RISKS RELATED TO THE SAME FACTORS, IN ADDITION TO THOSE ASSOCIATED WITH THESE MARKETS' SMALLER SIZE AND LESSER LIQUIDITY. THE FUND'S INVESTMENTS IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS ALSO INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS. THE FUND MAY INVEST IN LOWER RATED BONDS, WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: Shares are available to certain eligible investors as described in the prospectus. CLASS C: These shares have higher annual fees and expenses than Class A shares. CLASS R: Shares are available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. (1.) If the manager and administrator had not waived fees, the Fund's total returns would have been lower. (2.) Cumulative total return represents the change in value of an investment over the period indicated. (3.) Aggregate total return represents the change in value of an investment over the period indicated. Because the Fund has existed for less than one year, average annual total returns are not available. (4.) These figures represent the value of a hypothetical $10,000 investment in the Fund over the period indicated. (5.) Figures are as stated in the Fund's prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. 12 | Semiannual Report Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: - - Transaction costs, including sales charges (loads) on Fund purchases; and - - Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. Semiannual Report | 13 Your Fund's Expenses (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
EXPENSES PAID BEGINNING ACCOUNT DURING PERIOD* VALUE ACTUAL 5/1/09 ENDING ACCOUNT ACTUAL 5/1/09-6/30/09 HYPOTHETICAL 1/1/09 VALUE 6/30/09 HYPOTHETICAL 1/1/09-6/30/09 ------------------- -------------- --------------------------- CLASS Z Actual $1,000 $1,053.00 $ 1.97 Hypothetical (5% return before expenses) $1,000 $1,018.99 $ 5.86 CLASS A Actual $1,000 $1,053.00 $ 2.48 Hypothetical (5% return before expenses) $1,000 $1,017.50 $ 7.35 CLASS C Actual $1,000 $1,051.00 $ 3.66 Hypothetical (5% return before expenses) $1,000 $1,014.03 $10.84 CLASS R Actual $1,000 $1,053.00 $ 2.82 Hypothetical (5% return before expenses) $1,000 $1,016.51 $ 8.35
* Expenses are calculated using the most recent six-month expense ratio, net of expense waivers, annualized for each class (Z: 1.17%; A: 1.47%; C: 2.17%; and R: 1.67%), multiplied by the average account value over the period, multiplied by 181/365 (Hypothetical) to reflect the one-half year period. For Actual expenses, the multiplier is 60/365 to reflect the number of days since inception. 14 | Semiannual Report Mutual International Fund FINANCIAL HIGHLIGHTS
PERIOD ENDED JUNE 30, 2009(a) (UNAUDITED) ---------------- CLASS Z PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .......................... $10.00 ------ Income from investment operations(b): Net investment income(c) ................................... 0.05 Net realized and unrealized gains (losses) ................. 0.48 ------ Total from investment operations .............................. 0.53 ------ Net asset value, end of period ................................ $10.53 ====== Total return(d) ............................................... 5.30% RATIOS TO AVERAGE NET ASSETS(e) Expenses before waiver and payments by affiliates ............. 6.26% Expenses net of waiver and payments by affiliates ............. 1.17% Net investment income ......................................... 3.38% SUPPLEMENTAL DATA Net assets, end of period (000's) ............................. $1,219 Portfolio turnover rate ....................................... 1.39%
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. (b) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (c) Based on average daily shares outstanding. (d) Total return is not annualized for periods less than one year. (e) Ratios are annualized for periods less than one year. The accompanying notes are an integral part of these financial statements. Semiannual Report | 15 Mutual International Fund FINANCIAL HIGHLIGHTS (CONTINUED)
PERIOD ENDED JUNE 30, 2009(a) (UNAUDITED) ---------------- CLASS A PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .......................... $10.00 ------ Income from investment operations(b): Net investment income(c) ................................... 0.05 Net realized and unrealized gains (losses) ................. 0.48 ------ Total from investment operations .............................. 0.53 ------ Net asset value, end of period ................................ $10.53 ====== Total return(d) ............................................... 5.30% RATIOS TO AVERAGE NET ASSETS(e) Expenses before waiver and payments by affiliates ............. 6.56% Expenses net of waiver and payments by affiliates ............. 1.47% Net investment income ......................................... 3.08% SUPPLEMENTAL DATA Net assets, end of period (000's) ............................. $2,569 Portfolio turnover rate ....................................... 1.39%
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. (b) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (c) Based on average daily shares outstanding. (d) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (e) Ratios are annualized for periods less than one year. The accompanying notes are an integral part of these financial statements. 16 | Semiannual Report Mutual International Fund FINANCIAL HIGHLIGHTS (CONTINUED)
PERIOD ENDED JUNE 30, 2009(a) (UNAUDITED) ---------------- CLASS C PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .......................... $10.00 ------ Income from investment operations(b): Net investment income(c) ................................... 0.03 Net realized and unrealized gains (losses) ................. 0.48 ------ Total from investment operations .............................. 0.51 ------ Net asset value, end of period ................................ $10.51 ====== Total return(d) ............................................... 5.10% RATIOS TO AVERAGE NET ASSETS(e) Expenses before waiver and payments by affiliates ............. 7.26% Expenses net of waiver and payments by affiliates ............. 2.17% Net investment income ......................................... 2.38% SUPPLEMENTAL DATA Net assets, end of period (000's) ............................. $ 224 Portfolio turnover rate ....................................... 1.39%
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. (b) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (c) Based on average daily shares outstanding. (d) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (e) Ratios are annualized for periods less than one year. The accompanying notes are an integral part of these financial statements. Semiannual Report | 17 Mutual International Fund FINANCIAL HIGHLIGHTS (CONTINUED)
PERIOD ENDED JUNE 30, 2009(a) (UNAUDITED) ---------------- CLASS R PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the period) Net asset value, beginning of period .......................... $10.00 ------ Income from investment operations(b): Net investment income(c) ................................... 0.05 Net realized and unrealized gains (losses) ................. 0.48 ------ Total from investment operations .............................. 0.53 ------ Net asset value, end of period ................................ $10.53 ====== Total return(d) ............................................... 5.30% RATIOS TO AVERAGE NET ASSETS(e) Expenses before waiver and payments by affiliates ............. 6.76% Expenses net of waiver and payments by affiliates ............. 1.67% Net investment income ......................................... 2.88% SUPPLEMENTAL DATA Net assets, end of period (000's) ............................. $ 11 Portfolio turnover rate ....................................... 1.39%
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. (b) The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. (c) Based on average daily shares outstanding. (d) Total return does not reflect sales commissions or contingent deferred sales charges, if applicable, and is not annualized for periods less than one year. (e) Ratios are annualized for periods less than one year. The accompanying notes are an integral part of these financial statements. 18 | Semiannual Report Mutual International Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED)
COUNTRY SHARES VALUE -------------- ----------- ---------- COMMON STOCKS 88.7% AIR FREIGHT & LOGISTICS 0.4% TNT NV ........................................ Netherlands 840 $ 16,312 ---------- AUTOMOBILES 1.0% Daimler AG .................................... Germany 1,120 40,404 ---------- BEVERAGES 2.1% Carlsberg AS, B ............................... Denmark 714 45,789 Lion Nathan Ltd. .............................. Australia 4,288 39,950 ---------- 85,739 ---------- CAPITAL MARKETS 1.0% Man Group PLC ................................. United Kingdom 8,540 38,992 ---------- CHEMICALS 4.3% Akzo Nobel NV ................................. Netherlands 31 1,364 BASF SE ....................................... Germany 1,158 46,128 Huabao International Holdings Ltd. ............ Hong Kong 15,000 14,516 Koninklijke DSM NV ............................ Netherlands 608 19,043 Linde AG ...................................... Germany 621 50,893 Symrise AG .................................... Germany 2,758 40,695 ---------- 172,639 ---------- COMMERCIAL BANKS 7.5% Allied Irish Banks PLC ........................ Ireland 20,003 48,621 (a) Bank of Ireland ............................... Ireland 9,675 22,934 Barclays PLC .................................. United Kingdom 13,142 61,194 BNP Paribas SA ................................ France 769 49,885 (a) Intesa Sanpaolo SpA ........................... Italy 10,567 34,015 Intesa Sanpaolo SpA, di Risp .................. Italy 14,895 36,686 Societe Generale, A ........................... France 873 47,613 ---------- 300,948 ---------- COMPUTERS & PERIPHERALS 1.5% China Digital TV Holding Co., ADR ............. China 7,020 61,355 ---------- CONSTRUCTION & ENGINEERING 0.5% Vinci SA ...................................... France 450 20,188 ---------- CONSTRUCTION MATERIALS 2.2% CRH PLC ....................................... Ireland 1,740 39,781 SA des Ciments Vicat .......................... France 843 48,478 ---------- 88,259 ---------- DIVERSIFIED FINANCIAL SERVICES 4.5% Bolsas Y Mercados Espanoles ................... Spain 761 22,500 Deutsche Boerse AG ............................ Germany 647 50,166 (a) Fortis ........................................ Belgium 17,937 61,135 Groupe Bruxelles Lambert SA ................... Belgium 406 29,669 Hellenic Exchanges SA Holding ................. Greece 1,700 19,099 ---------- 182,569 ---------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.0% Koninklijke KPN NV ............................ Netherlands 4,455 61,230 Telefonica SA ................................. Spain 2,659 60,120 ---------- 121,350 ----------
Semiannual Report | 19 Mutual International Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY SHARES VALUE -------------- ----------- ---------- COMMON STOCKS (CONTINUED) ELECTRIC UTILITIES 2.3% E.ON AG ....................................... Germany 1,484 $ 52,515 Iride SpA ..................................... Italy 23,061 39,785 ---------- 92,300 ---------- FOOD & STAPLES RETAILING 5.9% AWB Ltd. ...................................... Australia 50,287 47,782 Carrefour SA .................................. France 1,256 53,590 Familymart Co. Ltd. ........................... Japan 1,300 40,878 Koninklijke Ahold NV .......................... Netherlands 5,004 57,440 Lawson Inc. ................................... Japan 900 39,602 ---------- 239,292 ---------- FOOD PRODUCTS 8.8% Cadbury PLC ................................... United Kingdom 5,735 48,879 (a) China Fishery Group Ltd. ...................... China 66,900 47,103 China Foods Ltd. .............................. China 50,000 30,065 Danone ........................................ France 1,197 59,064 First Pacific Co. Ltd. ........................ Hong Kong 72,029 41,359 Lotte Confectionary Co. Ltd. .................. South Korea 41 32,162 Nestle SA ..................................... Switzerland 1,652 62,195 Nong Shim Co. Ltd. ............................ South Korea 195 35,029 ---------- 355,856 ---------- HOTELS, RESTAURANTS & LEISURE 3.9% Accor SA ...................................... France 1,185 46,962 (a) Home Inns & Hotels Management Inc., ADR ....... China 3,600 57,204 (a) REXLot Holdings Ltd., fgn ..................... Bermuda 675,000 52,259 ---------- 156,425 ---------- HOUSEHOLD DURABLES 1.5% (a) Berkeley Group Holdings PLC ................... United Kingdom 4,439 58,758 ---------- INDUSTRIAL CONGLOMERATES 3.2% Jardine Matheson Holdings Ltd. ................ Hong Kong 1,200 32,904 Jardine Strategic Holdings Ltd. ............... Hong Kong 2,700 39,798 Koninklijke Philips Electronics NV ............ Netherlands 1,053 19,385 Siemens AG .................................... Germany 538 37,149 ---------- 129,236 ---------- INSURANCE 10.1% Austbrokers Holdings Ltd. ..................... Australia 12,831 40,812 AXA SA ........................................ France 2,853 53,581 Brit Insurance Holdings PLC ................... United Kingdom 8,503 26,442 Catlin Group Ltd. ............................. United Kingdom 6,100 32,268 CNinsure Inc., ADR ............................ China 5,380 72,146 Irish Life & Permanent PLC .................... Ireland 9,558 46,988 (a) Lancashire Holdings Ltd. ...................... United Kingdom 5,941 45,527 Tower Australia Group Ltd. .................... Australia 11,960 26,966 Zurich Financial Services AG .................. Switzerland 347 61,106 ---------- 405,836 ---------- LEISURE EQUIPMENT & PRODUCTS 1.0% Hutichison Harbour Ring Ltd. .................. Hong Kong 546,000 41,567 ----------
20 | Semiannual Report Mutual International Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
COUNTRY SHARES VALUE -------------- ----------- ---------- COMMON STOCKS (CONTINUED) LIFE SCIENCES TOOLS & SERVICES 0.5% (a) WuXi Pharmatech Cayman Inc., ADR .............. China 2,090 $ 19,730 ---------- MACHINERY 2.8% AB SKF, B ..................................... Sweden 1,370 16,867 Demag Cranes AG ............................... Germany 1,641 37,103 Schindler Holding AG, PC ...................... Switzerland 951 59,016 ---------- 112,986 ---------- MARINE 1.3% A.P. Moller - Maersk AS ....................... Denmark 9 53,903 ---------- MEDIA 6.4% Eutelsat Communications ....................... France 2,122 54,719 Seven Network Ltd. ............................ Australia 11,289 48,725 Sinomedia Holding ............................. China 226,800 52,969 (a) Visionchina Media Inc., ADR ................... China 9,860 60,245 Vivendi SA .................................... France 1,715 40,977 ---------- 257,635 ---------- MULTI-UTILITIES 4.3% Enia SpA ...................................... Italy 8,351 59,327 GDF Suez ...................................... France 1,392 51,817 RWE AG ........................................ Germany 761 60,093 ---------- 171,237 ---------- OIL, GAS & CONSUMABLE FUELS 2.5% Eni SpA ....................................... Italy 2,038 48,166 Total SA, B ................................... France 934 50,410 ---------- 98,576 ---------- PHARMACEUTICALS 1.6% China Pharmaceutical Group Ltd. ............... China 58,000 29,861 Novartis AG ................................... Switzerland 849 34,400 ---------- 64,261 ---------- REAL ESTATE INVESTMENT TRUST (REIT) 0.9% Link REIT ..................................... Hong Kong 17,000 36,282 ---------- TOBACCO 2.4% British American Tobacco PLC .................. United Kingdom 2,183 60,091 Japan Tobacco Inc. ............................ Japan 11 34,475 ---------- 94,566 ---------- WIRELESS TELECOMMUNICATION SERVICES 1.3% Vodafone Group PLC ............................ United Kingdom 26,126 50,380 ---------- TOTAL COMMON STOCKS (COST $ 3,411,133) ........ 3,567,581 ---------- PREFERRED STOCKS (COST $39,474) 1.1% AUTOMOBILES 1.1% Porsche Automobile Holding SE, pfd. ........... Germany 640 42,908 ----------
Semiannual Report | 21 Mutual International Fund STATEMENT OF INVESTMENTS, JUNE 30, 2009 (UNAUDITED) (CONTINUED)
PRINCIPAL COUNTRY AMOUNT(b) VALUE -------------- ----------- ---------- CORPORATE BONDS & NOTES 1.0% (c) Aiful Corp., senior note, 144A, 4.45%, 2/16/10 .................................... Japan 27,000 $ 19,713 (d) Chess Capital Securities, 4.83%, Perpetual .... Ireland 50,000 EUR 18,935 ---------- TOTAL CORPORATE BONDS & NOTES (COST $35,531) .. 38,648 ---------- TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS (COST $3,486,138) .......................... 3,649,137 ---------- SHORT TERM INVESTMENTS (COST $ 399,921) 9.9% U.S. GOVERNMENT AND AGENCY SECURITIES 9.9% (e) U.S. Treasury Bills, 8/20/09 .................. United States 400,000 399,919 ---------- TOTAL INVESTMENTS (COST $ 3,886,059) 100.7% ... 4,049,056 OTHER ASSETS, LESS LIABILITIES (0.7)% ......... (26,163) ---------- NET ASSETS 100.0% ............................. $4,022,893 ==========
(a) Non-income producing. (b) The principal amount is stated in U.S. dollars unless otherwise indicated. (c) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. This security has been deemed liquid under guidelines approved by the Trust's Board of Trustees. At June 30, 2009, the value of this security was $19,713, representing 0.49% of net assets. (d) Perpetual security with no stated maturity date. (e) The security is traded on a discount basis with no stated coupon rate. At June 30, 2009, the Fund had the following forward exchange contracts outstanding. See Note 1(c).
CONTRACT SETTLEMENT UNREALIZED UNREALIZED CURRENCY COUNTERPARTY TYPE QUANTITY AMOUNT DATE APPRECIATION DEPRECIATION - -------- ------------ ---- --------- ---------- ---------- ------------ ------------ British Pound .................... HSBC Sell 90,200 $ 141,526 7/13/09 $ -- $ (6,883) British Pound .................... SSBT Sell 111,800 184,462 7/13/09 515 -- Euro ............................. SSBT Sell 1,111,933 1,531,989 7/27/09 -- (27,635) Swiss Franc ...................... SSBT Sell 134,000 125,316 8/10/09 1,962 -- Australian Dollar ................ SSBT Sell 227,100 181,207 9/17/09 -- (570) ------ -------- Unrealized appreciation (depreciation) .................................................... 2,477 (35,088) ------ -------- Net unrealized appreciation (depreciation) ............................................. $(32,611) ========
See Abbreviations on page 35. The accompanying notes are an integral part of these financial statements. 22 | Semiannual Report Mutual International Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES June 30, 2009 (unaudited) Assets: Investments in securities: Cost ....................................................... $3,886,059 ---------- Value ...................................................... $4,049,056 Cash .......................................................... 56,467 Foreign currency, at value (cost $21,941) ..................... 21,870 Receivables: Investment securities sold ................................. 10,146 Capital shares sold ........................................ 7,190 Dividends and interest ..................................... 13,972 Affiliates ................................................. 20,916 Offering costs ................................................ 65,959 Unrealized appreciation on forward exchange contracts ......... 2,477 ---------- Total assets ............................................ 4,248,053 ---------- Liabilities: Payables: Investment securities purchased ............................ 95,801 Professional fees .......................................... 13,728 Offering costs ............................................. 78,935 Unrealized depreciation on forward exchange contracts ......... 35,088 Accrued expenses and other liabilities ........................ 1,608 ---------- Total liabilities ....................................... 225,160 ---------- Net assets, at value ................................. $4,022,893 ========== Net assets consist of: Paid-in capital ............................................... $3,879,607 Undistributed net investment income ........................ 16,657 Net unrealized appreciation (depreciation) ................. 130,674 Accumulated net realized gain (loss) ....................... (4,045) ---------- Net assets, at value ................................. $4,022,893 ==========
The accompanying notes are an integral part of these financial statements. Semiannual Report | 23 Mutual International Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) June 30, 2009 (unaudited) CLASS Z: Net assets, at value ........................................... $1,218,577 ---------- Shares outstanding ............................................. 115,714 ---------- Net asset value and maximum offering price per share ........... $ 10.53 ---------- CLASS A: Net assets, at value ........................................... $2,569,295 ---------- Shares outstanding ............................................. 243,993 ---------- Net asset value per share ...................................... $ 10.53 ---------- Maximum offering price per share (net asset value per share / 94.25%)(a) ...................................... $ 11.17 ---------- CLASS C: Net assets, at value ........................................... $ 224,495 ---------- Shares outstanding ............................................. 21,350 ---------- Net asset value and maximum offering price per share(a) ........ $ 10.51 ---------- CLASS R: Net assets, at value ........................................... $ 10,526 ---------- Shares outstanding ............................................. 1,000 ---------- Net asset value and maximum offering price per share(a) ........ $ 10.53 ----------
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable. The accompanying notes are an integral part of these financial statements. 24 | Semiannual Report Mutual International Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the period ended June 30, 2009(a) (unaudited) Investment income: Dividends (net of foreign taxes $3,441) ........................ $ 23,194 Interest ....................................................... 1,064 -------- Total investment income .................................. 24,258 -------- Expenses: Management fees (Note 3a) ...................................... 4,268 Administrative fees (Note 3b) .................................. 409 Distribution fees: (Note 3c) Class A ..................................................... 1,189 Class C ..................................................... 156 Class R ..................................................... 9 Transfer agent fees (Note 3e) .................................. 1,265 Custodian fees (Note 4) ........................................ 160 Reports to shareholders ........................................ 267 Registration and filing fees ................................... 267 Professional fees .............................................. 13,728 Trustees' fees and expenses .................................... 46 Amortization of offering costs ................................. 12,976 Other .......................................................... 50 -------- Total expenses ........................................... 34,790 Expenses waived/paid by affiliates (Note 3f) ............. (27,189) -------- Net expenses .......................................... 7,601 -------- Net investment income .............................. 16,657 -------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ................................................. 4,540 Foreign currency transactions ............................... (8,585) -------- Net realized gain (loss) ........................... (4,045) -------- Net change in unrealized appreciation (depreciation) on: Investments ................................................. 162,997 Translation of other assets and liabilities denominated in foreign currencies ........................ (32,323) -------- Net change in unrealized appreciation (depreciation) .................................. 130,674 -------- Net realized and unrealized gain (loss) ........................... 126,629 -------- Net increase (decrease) in net assets resulting from operations ................................................ $143,286 ========
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. The accompanying notes are an integral part of these financial statements. Semiannual Report | 25 Mutual International Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF CHANGES IN NET ASSETS
PERIOD ENDED JUNE 30, 2009(a) (UNAUDITED) ---------------- Increase (decrease) in net assets: Operations: Net investment income ...................................... $ 16,657 Net realized gain (loss) from investments and foreign currency transactions ................................... (4,045) Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies ........... 130,674 ---------- Net increase (decrease) in net assets resulting from operations ................................... 143,286 ---------- Capital share transactions: (Note 2) Class Z ................................................. 1,197,342 Class A ................................................. 2,448,908 Class C ................................................. 223,357 Class R ................................................. 10,000 ---------- Total capital share transactions .............................. 3,879,607 ---------- Net increase (decrease) in net assets ................ 4,022,893 ---------- Net Assets: Beginning of period ........................................... -- ---------- End of period ................................................. $4,022,893 ---------- Undistributed net investment income included in net assets: End of period ................................................. $ 16,657 ==========
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. The accompanying notes are an integral part of these financial statements. 26 | Semiannual Report Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds. The Mutual International Fund (Fund) is included in this report. The financial statements of the remaining funds in the Trust are presented separately. Effective May 1, 2009, the Fund commenced operations offering four classes of shares: Class Z, Class A, Class C, and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Equity and other securities listed on a securities exchange or on the NASDAQ National Market System are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Certain equity securities are valued based upon fundamental characteristics or relationships to similar securities. Corporate debt securities and government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Debt securities denominated in a foreign currency are converted into their U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the date that the values of the foreign debt securities are determined. Foreign equity securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. If no sale is reported at that time, the foreign equity security will be valued within the range of the most recent quoted bid and ask prices. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the security is determined. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Methods for valuing these securities may include: fundamental analysis based upon the underlying investment book value, anticipated future cash flows, market changes in comparable or similar securities, Semiannual Report | 27 Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Trustees. B. FOREIGN CURRENCY TRANSLATION Portfolio securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date of valuation. Purchases and sales of securities, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Trustees. The Fund does not separately report the effect of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized and unrealized gain or loss from investments on the Statement of Operations. Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. 28 | Semiannual Report Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. DERIVATIVE FINANCIAL INSTRUMENTS The Fund may invest in derivative financial instruments (derivatives) in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives may contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and the potential for market movements which may expose the Fund to gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities. Derivatives are marked to market daily based upon quotations from market makers or the Fund's independent pricing services and the Fund's net benefit or obligation under the contract, as measured by the fair market value of the contract, is included in net assets. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations. The Fund enters into forward exchange contracts in order to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between the Fund and a counter-party to buy or sell a foreign currency for a specific exchange rate on a future date. Pursuant to the terms of the forward exchange contacts, cash or securities may be required to be deposited as collateral. See Note 8 regarding other derivative information. D. FOREIGN CURRENCY CONTRACTS The Fund enters into foreign exchange contracts in order to manage foreign exchange rate risk between the trade date and settlement date of securities transactions. A foreign exchange contract is an agreement between the Fund and a counterparty to buy or sell a foreign currency for a specific exchange rate on a future date. E. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund has reviewed the tax position as of June 30, 2009, and has determined that no provision for income tax is required in the Fund's financial statements. Foreign securities held by the Fund may be subject to foreign taxation on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. Semiannual Report | 29 Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income is recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with accounting principles generally accepted in the United States of America. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. Common expenses incurred by the Trust are allocated among the funds based on the ratio of net assets of each fund to the combined net assets of the Trust. Fund specific expenses are charged directly to the fund that incurred the expense. Realized and unrealized gains and losses and net investment income, not including class specific expenses, are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions, by class, are generally due to differences in class specific expenses. G. OFFERING COSTS Offering costs are amortized on a straight line basis over twelve months. H. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. I. GUARANTEES AND INDEMNIFICATIONS Under the Trust's organizational documents, its officers and trustees are indemnified by the Trust against certain liabilities arising out of the performance of their duties to the Trust. Additionally, in the normal course of business, the Trust, on behalf of the Fund, enters into contracts with service providers that contain general indemnification clauses. The Trust's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Trust that have not yet occurred. Currently, the Trust expects the risk of loss to be remote. 30 | Semiannual Report Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 2. SHARES OF BENEFICIAL INTEREST At June 30, 2009, there were an unlimited number of shares authorized (without par value). Transactions in the Fund's shares were as follows:
PERIOD ENDED JUNE 30, 2009(a) -------------------- SHARES AMOUNT ------- ---------- CLASS Z SHARES: Shares sold ......................... 115,714 $1,197,342 ------- ---------- Net increase (decrease) ............. 115,714 $1,197,342 ------- ---------- CLASS A SHARES: Shares sold ......................... 244,949 $2,458,908 Shares redeemed ..................... (956) (10,000) ------- ---------- Net increase (decrease) ............. 243,993 $2,448,908 ------- ---------- CLASS C SHARES: Shares sold ......................... 21,350 $ 223,357 ------- ---------- Net increase (decrease) ............. 21,350 $ 223,357 ------- ---------- CLASS R SHARES: Shares sold ......................... 1,000 $ 10,000 ------- ---------- Net increase (decrease) ............. 1,000 $ 10,000 ------- ----------
(a) For the period May 1, 2009 (commencement of operations) to June 30, 2009. 3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and trustees of the Trust are also officers and/or directors of the following subsidiaries:
SUBSIDIARY AFFILIATION - ---------- ---------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES The Fund pays an investment management fee to Franklin Mutual of 0.80% per year of the average daily net assets of the Fund. Semiannual Report | 31 Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Trust's aggregate average daily net assets as follows:
ANNUALIZED FEE RATE NET ASSETS - ------------------- ---------------------------------------------------------- 0.150% Up to and including $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% In excess of $ 1.2 billion
C. DISTRIBUTION FEES The Fund's Board of Trustees has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class C and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ........... 0.35% Class C ........... 1.00% Class R ........... 0.50%
Prior to the Fund's commencement of operations, the Board of Trustees has set the current rate at 0.30% per year for Class A shares until further notice and approval by the Board. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the period: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................. $228 Contingent deferred sales charges retained ...... $ --
E. TRANSFER AGENT FEES For the period ended June 30, 2009, the Fund paid transfer agent fees of $1,265, of which $393 was retained by Investor Services. 32 | Semiannual Report Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) F. WAIVER AND EXPENSE REIMBURSEMENTS FT Services and Franklin Mutual have agreed in advance to waive all or a portion of their respective fees and to assume payment of other expenses through April 30, 2010. Total expenses waived or paid are not subject to reimbursement by the Fund subsequent to the Fund's fiscal year end. After April 30, 2010, FT Services and Franklin Mutual may discontinue this waiver at any time upon notice to the Fund's Board of Trustees. G. OTHER AFFILIATED TRANSACTIONS At June 30, 2009, Franklin Advisers Inc. owned 52% of the Fund's outstanding shares. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended June 30, 2009, there were no credits earned. 5. INCOME TAXES At June 30, 2009, the cost of investments and net unrealized appreciation (depreciation) for income tax purposes were as follows: Cost of investments ............................. $3,886,059 ========== Unrealized appreciation ......................... $ 212,768 Unrealized depreciation ......................... (49,771) ---------- Net unrealized appreciation (depreciation) ...... $ 162,997 ==========
Net investment income differs for financial statement and tax purposes primarily due to differing treatments of foreign currency transactions and offering costs. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatment of foreign currency transactions. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities) for the period ended June 30, 2009, aggregated $3,517,349 and $40,175, respectively. Semiannual Report | 33 Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 7. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 8. OTHER DERIVATIVE INFORMATION At June 30, 2009, the Fund has invested in derivative contracts which are reflected on the Statement of Assets and Liabilities as follows:
ASSET DERIVATIVES LIABILITY DERIVATIVES --------------------------------------- --------------------------------------- DERIVATIVE CONTRACTS NOT ACCOUNTED FOR AS HEDGING INSTRUMENTS UNDER FASB STATEMENT STATEMENT OF ASSETS AND FAIR VALUE STATEMENT OF ASSETS AND FAIR VALUE NO. 133 LIABILITIES LOCATION AMOUNT LIABILITIES LOCATION AMOUNT - -------------------- -------------------------- ---------- -------------------------- ---------- Foreign exchange contracts ....... Unrealized appreciation on Unrealized depreciation on forward exchange contracts $2,477 forward exchange contracts $35,088
For the period ended June 30, 2009, the effect of derivative contracts on the Fund's Statement of Operations was as follows:
UNREALIZED APPRECIATION DERIVATIVE CONTRACTS REALIZED GAIN (DEPRECIATION) AVERAGE NOT ACCOUNTED FOR AS (LOSS) FOR THE FOR THE AMOUNT HEDGING INSTRUMENTS PERIOD ENDED PERIOD ENDED OUTSTANDING UNDER FASB STATEMENT STATEMENT OF JUNE 30, JUNE 30, DURING THE NO. 133 OPERATIONS LOCATIONS 2009 2009 PERIOD(a) - -------------------- -------------------------------------- -------------- -------------- ----------- Foreign exchange contracts ....... Net realized gain (loss) from foreign currency transactions/Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies $-- $(32,611) 1,161,633
(a) Represents the average notional amount outstanding during the period. For derivative contracts denominated in foreign currencies, notional amounts are converted into U.S. dollars. See Note 1(c) regarding derivative financial instruments. 34 | Semiannual Report Mutual International Fund NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 9. FAIR VALUE MEASUREMENTS Financial Accounting Standards Board (FASB) Statement No. 157, "Fair Value Measurement" (SFAS 157) establishes a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund's own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund's investments and are summarized in the following fair value hierarchy: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used as of June 30, 2009 in valuing the Fund's assets and liabilities carried at fair value:
LEVEL 1 LEVEL 2 LEVEL 3 TOTAL ---------- ------- ------- ---------- ASSETS: Investments in Secuities: Equity ...................... $3,610,489 $ -- $-- $3,610,489 Investments(a, b) Corporate Bonds & Notes ..... -- 38,648 -- 38,648 Short Term Investments ...... 399,919 -- -- 399,919 ---------- ------- --- ---------- Total Investments in Securities ............ $4,010,408 $38,648 $-- $4,049,056 ========== ======= === ========== Forward Exchange Contracts .. $ -- $ 2,477 $-- $ 2,477 LIABILITIES: Forward Exchange Contracts .. -- 35,088 -- 35,088
(a) Includes common and preferred stock as well as other equity investments. (b) For detailed industry descriptions, see the accompanying Statement of Investments. 10. SUBSEQUENT EVENTS Management has evaluated subsequent events through August 17, 2009 and determined that no events have occurred that required disclosure. ABBREVIATIONS CURRENCY EUR - Euro SELECTED PORTFOLIO ADR - American Depository Receipt PC - Participation Certificate COUNTERPARTY HSBC - HSBC Bank USA SSBT - State Street Bank and Trust Co. Semiannual Report | 35 Mutual International Fund SHAREHOLDER INFORMATION BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees (Board), including the independent trustees, in 2009, unanimously approved the Fund's investment management agreement, as well as the Fund's administrative services agreement. Prior to a meeting of all the trustees for the purpose of considering such approval, the independent trustees held a meeting dedicated to the approval process. The independent trustees received assistance and advice from and met separately with independent counsel. The independent trustees met with and interviewed officers of the investment manager and its affiliates. In approving the investment management agreement and the administrative services agreement for the Fund, the Board, including the independent trustees, determined that the investment management fee structure was fair and reasonable and that approval of the agreements was in the best interests of the Fund and its shareholders. In reaching its decision on the investment management agreement (as well as the administrative services agreement), the Board took into account information furnished in connection with the approval process. The information obtained by the Board in connection with the approval process also included information about other international multi-cap value funds, as categorized by Lipper, Inc. (Lipper), an independent third-party analyst, so that the Board could compare the Fund's proposed expenses with those of other international multi-cap value funds. The Board reviewed this information and its usefulness in the approval process with respect to matters such as comparative fees and expense ratios. They concluded that the information was helpful in the performance of their duties. In evaluating the investment manager's ability to implement the Fund's proposed investment approach, the trustees took into account the actions taken by the investment manager and its affiliates in response to problems arising out of the market turmoil and financial crisis experienced in the last year. In this respect, the Board noted that management's independent credit analysis and diligent risk management procedures had minimized exposure of funds within the Franklin Templeton complex to subprime mortgages and that its continuous monitoring of counterparty credit risk had limited fund exposure to firms experiencing financial difficulties like Bear Stearns and AIG. The same type of conservative approach and attention to risk had also prevented any structured investment products or other volatile instruments from being held in the portfolios of any of the money market funds within the Franklin Templeton complex. The Board also took into account, among other things, the strong financial position of Franklin Resources, Inc., the investment manager's parent company, and its commitment to the mutual fund business. The trustees also noted that during the past year Franklin Resources, Inc., like many other fund managers, had announced a hiring freeze and implemented employee reductions and the trustees discussed with management the nature of such reductions and the steps taken to minimize any negative impact on the nature and quality of the services to be provided to the Fund. In addition to the above and other matters considered by the trustees throughout the course of the year as trustees of other Mutual Series funds, the following discussion relates to certain primary factors relevant to the Board's decision. This discussion of the information and factors considered by the Board (as well as the discussion above) is not intended to be exhaustive, but rather summarizes 36 | SEMIANNUAL REPORT Mutual International Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) certain factors considered by the Board. In view of the wide variety of factors considered, the Board did not, unless otherwise noted, find it practicable to quantify or otherwise assign relative weights to the foregoing factors. In addition, individual trustees may have assigned different weights to various factors. NATURE, EXTENT AND QUALITY OF SERVICES. The trustees reviewed the nature, extent and quality of the services to be provided by the investment manager. In this regard, they reviewed the Fund's proposed investment approach and the investment manager's ability to implement such approach. The trustees considered the successful performance of the investment manager in managing the other Mutual Series funds. The trustees reviewed the Fund's portfolio management team, including its performance, staffing, skills and compensation program. The trustees considered various other products, portfolios and entities that are advised by the investment manager and the allocation of assets and expenses among and within them, as well as their relative fees and reasons for differences with respect thereto and any potential conflicts. The Board also considered other reports and presentations it received in connection with other Mutual Series funds regarding the investment manager's adherence with the policies and procedures of the other Mutual Series funds. The Board noted the extent of the benefits that will be provided to Fund shareholders from being part of the Franklin Templeton group, including the right to exchange investments between funds (same class) without a sales charge, the ability to reinvest Fund dividends into other funds and the right to combine holdings of other funds to obtain reduced sales charges. The trustees considered the significant recent efforts to develop, test and implement compliance procedures established in accordance with SEC requirements. They also considered the nature, extent and quality of the services to be provided under the other service agreements with affiliates of the investment manager. Based on their review, the trustees were satisfied with the nature and quality of the overall services to be provided by the investment manager and its affiliates to the Fund and its shareholders and were confident in the abilities of the management team to implement the proposed disciplined value investment approach of the Fund and to provide quality services to the Fund and its shareholders. INVESTMENT PERFORMANCE. The Board noted that, as the Fund had not yet commenced investment operations, there was no investment performance for the Fund. The Board did consider the investment performance of the investment manager with respect to the other Mutual Series funds. COMPARATIVE EXPENSES AND PROFITABILITY. The Board considered the cost of the services to be provided and the profits to be realized by the investment manager (and its affiliates) from their respective relationships with the Fund. The Board noted that the investment manager and its affiliates could not report any financial results from their relationships with the Fund because the Fund had not yet commenced investment operations, and thus, the Board could not evaluate the investment manager's and its affiliate's profitability with respect to the Fund. The Board considered the extent to which the investment manager may derive ancillary benefits from Fund operations. Semiannual Report | 37 Mutual International Fund SHAREHOLDER INFORMATION (CONTINUED) BOARD REVIEW OF INVESTMENT MANAGEMENT AGREEMENT (CONTINUED) In considering the appropriateness of the investment management fee charged to the Fund, the Board also reviewed and considered the investment management fees in light of the nature, extent and quality of the investment management services expected to be provided by the investment manager, including, but not limited to, the quality and experience of the portfolio managers. The independent trustees also considered the fees charged to other Mutual Series funds. As part of this discussion, the Board took into account the proposed fee waiver and expense limitation arrangements that would be in effect for the first year of operation. Consideration was also given to the information provided on other international multi-cap value funds, as categorized by Lipper, particularly the comparison of the investment management fee and total expense ratios of the Fund to those other funds (Class A shares). The Board noted that the actual investment management fee of the Fund was within the range of fees charged by such other funds. The Board also noted that the total expenses (both including and excluding the proposed fee waiver and expense limitation arrangements) of the Fund were within the range of total expenses of such other funds. Based upon its consideration of all these factors, the Board determined that the investment management fee structure was fair and reasonable. ECONOMIES OF SCALE. The Board considered economies of scale realized by the investment manager and its affiliates as the Fund grows larger and the extent to which they are shared with Fund shareholders, as for example, in the level of the investment management fee charged, in the quality and efficiency of services rendered and in increased capital commitments benefiting the Fund directly or indirectly. Since the Fund had not yet commenced operations, the Board concluded that economies of scale were difficult to consider at that time. PROXY VOTING POLICIES AND PROCEDURES The Fund's investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission's website at sec.gov and reflect the period from May 1, 2009 (commencement of operations) to June 30, 2009. 38 | Semiannual Report Mutual International Fund SHAREHOLDER INFORMATION (CONTINUED) QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling (800) SEC-0330. Semiannual Report | 39 This page intentionally left blank. Franklin Templeton Funds LITERATURE REQUEST. TO RECEIVE A PROSPECTUS, PLEASE CALL US AT (800) DIAL BEN/(800) 342-5236 OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund(1) Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Quest Fund Mutual Recovery Fund(2) Mutual Shares Fund BLEND Franklin Focused Core Equity Fund Franklin Large Cap Equity Fund Franklin Rising Dividends Fund GROWTH Franklin Flex Cap Growth Fund Franklin Growth Fund Franklin Growth Opportunities Fund Franklin Small Cap Growth Fund Franklin Small-Mid Cap Growth Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Real Estate Fund Franklin Gold & Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Mutual Financial Services Fund GLOBAL Mutual Global Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund INTERNATIONAL Franklin India Growth Fund Franklin International Growth Fund Franklin International Small Cap Growth Fund Mutual European Fund Mutual International Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton Frontier Markets Fund HYBRID Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Income Fund Templeton Income Fund ASSET ALLOCATION Franklin Templeton Corefolio(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund FIXED INCOME Franklin Adjustable U.S. Government Securities Fund(3) Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Limited Maturity U.S. Government Securities Fund(3) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(3) Templeton Global Bond Fund Templeton Global Total Return Fund Templeton International Bond Fund TAX-FREE INCOME(4) NATIONAL Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(5) LIMITED-/INTERMEDIATE-TERM California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California(6) Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts(7) Michigan(7) Minnesota(7) Missouri New Jersey New York(6) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (1.) The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. (2.) The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. (3.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (4.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (5.) The fund invests primarily in insured municipal securities. (6.) These funds are available in four or more variations, including long-term portfolios, intermediate-term portfolios, portfolios of insured securities, a high-yield portfolio (CA only) and money market portfolios. (7.) The Board of Trustees approved the elimination of the non-fundamental policy requiring the fund to invest at least 80% of net assets in insured municipal securities and the removal of the word "Insured" from the fund name. The changes became effective 2/17/09. (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 04/09 Not part of the semiannual report (FRANKLIN TEMPLETON INVESTMENTS(R) LOGO) One Franklin Parkway San Mateo, CA 94403-1906 SIGN UP FOR EDELIVERY Log onto franklintempleton.com and click "My Profile" SEMIANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL INTERNATIONAL FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. (800) DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES (800) 632-2301 - (Class A, C & R) (800) 448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 373 S2009 08/09 ITEM 2. CODE OF ETHICS. (a) The Registrant has adopted a code of ethics that applies to its principal executive officers and principal financial and accounting officer. (c) N/A (d) N/A (f) Pursuant to Item 12(a)(1), the Registrant is attaching as an exhibit a copy of its code of ethics that applies to its principal executive officers and principal financial and accounting officer. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. (a)(1) The registrant has an audit committee financial expert serving on its audit committee. (2) The audit committee financial expert is Ann Torre Bates, and she is "independent" as defined under the relevant Securities and Exchange Commission Rules and Releases. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. N/A ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. N/A ITEM 6. SCHEDULE OF INVESTMENTS. N/A ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. N/A ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. N/A ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. N/A ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no changes to the procedures by which shareholders may recommend nominees to the Registrant's board of trustees that would require disclosure herein. ITEM 11. CONTROLS AND PROCEDURES. (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Registrant maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Registrant's filings under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to the Registrant's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Registrant's management, including the principal executive officer and the principal financial officer, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Within 90 days prior to the filing date of this Shareholder Report on Form N-CSR, the Registrant had carried out an evaluation, under the supervision and with the participation of the Registrant's management, including the Registrant's principal executive officer and the Registrant's principal financial officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures. Based on such evaluation, the Registrant's principal executive officer and principal financial officer concluded that the Registrant's disclosure controls and procedures are effective. (b) ______ CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the Registrant's internal controls or in other factors that could significantly affect the internal controls subsequent to the date of their evaluation in connection with the preparation of this Shareholder Report on Form N-CSR. ITEM 12. EXHIBITS. (a)(1) Code of Ethics (A)(2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Laura F. Fergerson, Chief Executive Officer - Finance and Administration, and Matthew T. Hinkle, Chief Financial Officer and Chief Accounting Officer (B) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Laura F. Fergerson, Chief Executive Officer - Finance and Administration, and Matthew T. Hinkle, Chief Financial Officer and Chief Accounting Officer SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FRANKLIN MUTUAL SERIES FUNDS By /s/ LAURA F. FERGERSON ----------------------------- Laura F. Fergerson Chief Executive Officer - Finance and Administration Date August 27, 2009 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/ LAURA F. FERGERSON ----------------------------- Laura F. Fergerson Chief Executive Officer - Finance and Administration Date August 27, 2009 By /s/MATTHEW T. HINKLE -------------------------------- Matthew T. Hinkle Chief Financial Officer and Chief Accounting Officer Date August 27, 2009 EX-99.CODE ETH 2 ncsr_code1208.txt CODE OF ETHICS Exhibit 12(a)(1) CODE OF ETHICS FOR PRINCIPAL EXECUTIVES & SENIOR FINANCIAL OFFICERS - ------------------------------------------------------------------------------ PROCEDURES Revised December 22, 2008 - ------------------------------------------------------------------------------- FRANKLIN TEMPLETON FUNDS CODE OF ETHICS FOR PRINCIPAL EXECUTIVE AND SENIOR FINANCIAL OFFICERS I. Covered Officers and Purpose of the Code This code of ethics (the "Code") applies to the Principal Executive Officers, Principal Financial Officer and Principal Accounting Officer (the "Covered Officers," each of whom is set forth in Exhibit A) of each investment company advised by a Franklin Resources subsidiary and that is registered with the United States Securities & Exchange Commission ("SEC") (collectively, "FT Funds") for the purpose of promoting: o Honest and ethical conduct, including the ethical resolution of actual or apparent conflicts of interest between personal and professional relationships; o Full, fair, accurate, timely and understandable disclosure in reports and documents that a registrant files with, or submits to, the SEC and in other public communications made by or on behalf of the FT Funds; o Compliance with applicable laws and governmental rules and regulations; o The prompt internal reporting of violations of the Code to an appropriate person or persons identified in the Code; and o Accountability for adherence to the Code. Each Covered Officer will be expected to adhere to a high standard of business ethics and must be sensitive to situations that may give rise to actual as well as apparent conflicts of interest. II. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the Funds for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Franklin Resources, Inc. has separately adopted the CODE OF ETHICS AND BUSINESS CONDUCT ("Business Conduct"), which is applicable to all officers, directors and employees of Franklin Resources, Inc., including Covered Officers. It summarizes the values, principles and business practices that guide the employee's business conduct and also provides a set of basic principles to guide officers, directors and employees regarding the minimum ethical requirements expected of them. It supplements the values, principles and business conduct identified in the Code and other existing employee policies. Additionally, the Franklin Templeton Funds have separately adopted the CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING governing personal securities trading and other related matters. The Code for Insider Trading provides for separate requirements that apply to the Covered Officers and others, and therefore is not part of this Code. Insofar as other policies or procedures of Franklin Resources, Inc., the Funds, the Funds' adviser, principal underwriter, or other service providers govern or purport to govern the behavior or activities of the Covered Officers who are subject to this Code, they are superceded by this Code to the extent that they overlap or conflict with the provisions of this Code. Please review these other documents or consult with the Legal Department if have questions regarding the applicability of these policies to you. III. Covered Officers Should Handle Ethically Actual and Apparent Conflicts of Interest OVERVIEW. A "conflict of interest" occurs when a Covered Officer's private interest interferes with the interests of, or his or her service to, the FT Funds. For example, a conflict of interest would arise if a Covered Officer, or a member of his family, receives improper personal benefits as a result of apposition with the FT Funds. Certain conflicts of interest arise out of the relationships between Covered Officers and the FT Funds and already are subject to conflict of interest provisions in the Investment Company Act of 1940 ("Investment Company Act") and the Investment Advisers Act of 1940 ("Investment Advisers Act"). For example, Covered Officers may not individually engage in certain transactions (such as the purchase or sale of securities or other property) with the FT Funds because of their status as "affiliated persons" of the FT Funds. The FT Funds' and the investment advisers' compliance programs and procedures are designed to prevent, or identify and correct, violations of these provisions. This Code does not, and is not intended to, repeat or replace these programs and procedures, and such conflicts fall outside of the parameters of this Code. Although typically not presenting an opportunity for improper personal benefit, conflicts arise from, or as a result of, the contractual relationship between the FT Funds, the investment advisers and the fund administrator of which the Covered Officers are also officers or employees. As a result, this Code recognizes that the Covered Officers will, in the normal course of their duties (whether formally for the FT Funds, for the adviser, the administrator, or for all three), be involved in establishing policies and implementing decisions that will have different effects on the adviser, administrator and the FT Funds. The participation of the Covered Officers in such activities is inherent in the contractual relationship between the FT Funds, the adviser, and the administrator and is consistent with the performance by the Covered Officers of their duties as officers of the FT Funds. Thus, if performed in conformity with the provisions of the Investment Company Act and the Investment Advisers Act, such activities will be deemed to have been handled ethically. In addition, it is recognized by the FT Funds' Boards of Directors ("Boards") that the Covered Officers may also be officers or employees of one or more other investment companies covered by this or other codes. Other conflicts of interest are covered by the Code, even if such conflicts of interest are not subject to provisions in the Investment Company Act and the Investment Advisers Act. The following list provides examples of conflicts of interest under the Code, but Covered Officers should keep in mind that these examples are not exhaustive. The overarching principle is that the personal interest of a Covered Officer should not be placed improperly before the interest of the FT Funds. Each Covered Officer must: o Not use his or her personal influence or personal relationships improperly to influence investment decisions orfinancial reporting by the FT Funds whereby the Covered Officer would benefit personally to the detriment of the FT Funds; o Not cause the FT Funds to take action, or fail to take action, for the individual personal benefit of the Covered Officer rather than the benefit the FT Funds; o Not retaliate against any other Covered Officer or any employee of the FT Funds or their affiliated persons for reports of potential violations that are made in good faith; o Report at least annually the following affiliations or other relationships:/ 1 o all directorships for public companies and all companies that are required to file reports with the SEC; o any direct or indirect business relationship with any independent directors of the FT Funds; o any direct or indirect business relationship with any independent public accounting firm (which are not related to the routine issues related to the firm's service as the Covered Persons accountant); and o any direct or indirect interest in any transaction with any FT Fund that will benefit the officer (not including benefits derived from the advisory, sub-advisory, distribution or service agreements with affiliates of Franklin Resources). These reports will be reviewed by the Legal Department for compliance with the Code. There are some conflict of interest situations that should always be approved in writing by Franklin Resources General Counsel or Deputy General Counsel, if material. Examples of these include/2: o Service as a director on the board of any public or private Company; o The receipt of any gifts in excess of $100 from any person, from any corporation or association o The receipt of any entertainment from any Company with which the FT Funds has current or prospective business dealings unless such entertainment is business related, reasonable in cost, appropriate as to time and place, and not so frequent as to raise any question of impropriety. Notwithstanding the foregoing, the Covered Officers must obtain prior approval from the Franklin Resources General Counsel for any entertainment with a value in excess of $1000. o Any ownership interest in, or any consulting or employment relationship with, any of the FT Fund's service providers, other than an investment adviser, principal underwriter, administrator or any affiliated person thereof; o A direct or indirect financial interest in commissions, transaction charges or spreads paid by the FT Funds for effecting portfolio transactions or for selling or redeeming shares other than an interest arising from the Covered Officer's employment, such as compensation or equity ownership. Franklin Resources General Counsel or Deputy General Counsel will provide a report to the FT Funds Audit Committee of any approvals granted at the next regularly scheduled meeting. IV. Disclosure and Compliance o Each Covered Officer should familiarize himself with the disclosure requirements generally applicable to the FT Funds; o Each Covered Officer should not knowingly misrepresent, or cause others to misrepresent, facts about the FT Funds to others, whether within or outside the FT Funds, including to the FT Funds' directors and auditors, and to governmental regulators and self-regulatory organizations; o Each Covered Officer should, to the extent appropriate within his or her area of responsibility, consult with other officers and employees of the FT Funds, the FT Fund's adviser and the administrator with the goal of promoting full, fair, accurate, timely and understandable disclosure in the reports and documents the FT Funds file with, or submit to, the SEC and in other public communications made by the FT Funds; and o It is the responsibility of each Covered Officer to promote compliance with the standards and restrictions imposed by applicable laws, rules and regulations. V. Reporting and Accountability Each Covered Officer must: o Upon becoming a covered officer affirm in writing to the Board that he or she has received, read, and understands the Code (see Exhibit B); o Annually thereafter affirm to the Board that he has complied with the requirements of the Code; and o Notify Franklin Resources' General Counsel or Deputy General Counsel promptly if he or she knows of any violation of this Code. Failure to do so is itself is a violation of this Code. Franklin Resources' General Counsel and Deputy General Counsel are responsible for applying this Code to specific situations in which questions are presented under it and have the authority to interpret this Code in any particular situation./3 However, the Independent Directors of the respective FT Funds will consider any approvals or waivers/4 sought by any Chief Executive Officers of the Funds. The FT Funds will follow these procedures in investigating and enforcing this Code: o Franklin Resources General Counsel or Deputy General Counsel will take all appropriate action to investigate any potential violations reported to the Legal Department; o If, after such investigation, the General Counsel or Deputy General Counsel believes that no violation has occurred, The General Counsel is not required to take any further action; o Any matter that the General Counsel or Deputy General Counsel believes is a violation will be reported to the Independent Directors of the appropriate FT Fund; o If the Independent Directors concur that a violation has occurred, it will inform and make a recommendation to the Board of the appropriate FT Fund or Funds, which will consider appropriate action, which may include review of, and appropriate modifications to, applicable policies and procedures; notification to appropriate personnel of the investment adviser or its board; or a recommendation to dismiss the Covered Officer; o The Independent Directors will be responsible for granting waivers, as appropriate; and o Any changes to or waivers of this Code will, to the extent required, are disclosed as provided by SEC rules./5 VI. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the FT Funds for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Insofar as other policies or procedures of the FT Funds, the FT Funds' advisers, principal underwriter, or other service providers govern or purport to govern the behavior or activities of the Covered Officers who are subject to this Code, they are superseded by this Code to the extent that they overlap or conflict with the provisions of this Code. The FT Code of Ethics and Policy Statement On Insider Trading, adopted by the FT Funds, FT investment advisers and FT Fund's principal underwriter pursuant to Rule 17j-1 under the Investment Company Act, the Code of Ethics and Business Conduct and more detailed policies and procedures set forth in FT's Employee Handbook are separate requirements applying to the Covered Officers and others, and are not part of this Code. VII. Amendments Any amendments to this Code, other than amendments to Exhibit A, must be approved or ratified by a majority vote of the FT Funds' Board including a majority of independent directors. VIII. Confidentiality All reports and records prepared or maintained pursuant to this Code will be considered confidential and shall be maintained and protected accordingly. Except as otherwise required by law or this Code, such matters shall not be disclosed to anyone other than the FT Funds' Board and their counsel. IX. Internal Use The Code is intended solely for the internal use by the FT Funds and does not constitute an admission, by or on behalf of any FT Funds, as to any fact, circumstance, or legal conclusion. X. Disclosure on Form N-CSR Item 2 of Form N-CSR requires a registered management investment company to disclose annually whether, as of the end of the period covered by the report, it has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these officers are employed by the registrant or a third party. If the registrant has not adopted such a code of ethics, it must explain why it has not done so. The registrant must also: (1) file with the SEC a copy of the code as an exhibit to its annual report; (2) post the text of the code on its Internet website and disclose, in its most recent report on Form N-CSR, its Internet address and the fact that it has posted the code on its Internet website; or (3) undertake in its most recent report on Form N-CSR to provide to any person without charge, upon request, a copy of the code and explain the manner in which such request may be made. Disclosure is also required of amendments to, or waivers (including implicit waivers) from, a provision of the code in the registrant's annual report on Form N-CSR or on its website. If the registrant intends to satisfy the requirement to disclose amendments and waivers by posting such information on its website, it will be required to disclose its Internet address and this intention. The Legal Department shall be responsible for ensuring that: o a copy of the Code is filed with the SEC as an exhibit to each Fund's annual report; and o any amendments to, or waivers (including implicit waivers) from, a provision of the Code is disclosed in the registrant's annual report on Form N-CSR. In the event that the foregoing disclosure is omitted or is determined to be incorrect, the Legal Department shall promptly file such information with the SEC as an amendment to Form N-CSR. In such an event, the Fund Chief Compliance Officer shall review the Code and propose such changes to the Code as are necessary or appropriate to prevent reoccurrences. EXHIBIT A Persons Covered by the Franklin Templeton Funds Code of Ethics December 2008 FRANKLIN GROUP OF FUNDS Edward B. Jamieson President and Chief Executive Officer - Investment Management Charles B. Johnson President and Chief Executive Officer - Investment Management Rupert H. Johnson, Jr. President and Chief Executive Officer - Investment Management William J. Lippman President and Chief Executive Officer - Investment Management Christopher Molumphy President and Chief Executive Officer - Investment Management Jennifer J. Bolt Chief Executive Officer - Finance and Administration Laura Fergerson Chief Financial Officer and Chief Accounting Officer FRANKLIN MUTUAL SERIES FUNDS Peter Langerman Chief Executive Officer-Investment Management Jennifer J. Bolt Chief Executive Officer - Finance and Administration Laura Fergerson Chief Financial Officer and Chief Accounting Officer TEMPLETON GROUP OF FUNDS Mark Mobius President and Chief Executive Officer - Investment Management Christopher J. Molumphy President and Chief Executive Officer - Investment Management Gary P. Motyl President and Chief Executive Officer - Investment Management Donald F. Reed President and Chief Executive Officer - Investment Management Jennifer J. Bolt Chief Executive Officer - Finance and Administration Laura Fergerson Chief Financial Officer and Chief Accounting Officer EXHIBIT B ACKNOWLEDGMENT FORM DECEMBER FRANKLIN TEMPLETON FUNDS CODE OF ETHICS FOR PRINCIPAL EXECUTIVE AND SENIOR FINANCIAL OFFICERS INSTRUCTIONS: 1. Complete all sections of this form. 2. Print the completed form, sign, and date. 3. Submit completed form to FT's General Counsel c/o Code of Ethics Administration within 10 days of becoming a Covered Officer and by January 30th of each subsequent year. INTER-OFFICE MAIL: Code of Ethics Administration, Global Compliance SM-920/2 TELEPHONE: (650) 312-5698 Fax: (650) 312-5646 E-MAIL: Preclear-Code of Ethics (internal address); lpreclear@frk.com (external address) - ------------------------------------------------------------------------------ COVERED OFFICER'S NAME: - ------------------------------------------------------------------------------ TITLE: - ------------------------------------------------------------------------------ DEPARTMENT: - ------------------------------------------------------------------------------ LOCATION: - ------------------------------------------------------------------------------ CERTIFICATION FOR YEAR ENDING: - ------------------------------------------------------------------------------ TO: Franklin Resources General Counsel, Legal Department I hereby acknowledge receipt of a copy of Franklin Templeton Fund's code of ethics for Principal Executive Officers and Senior Financial Officers (the "Code") that I have read and understand. I will comply fully with all provisions of the Code to the extent they apply to me during the period of my employment. I further understand and acknowledge that any violation of the Code may subject me to disciplinary action, including termination of employment. ---------------------------- ---------------------- Signature Date signed - ----------------------------- 1. Reporting of these affiliations or other relationships shall be made by completing the annual Directors and Officers Questionnaire and returning the questionnaire to Franklin Resources Inc, General Counsel or Deputy General Counsel. 2. Any activity or relationship that would present a conflict for a Covered Officer may also present a conflict for the Covered Officer if a member of the Covered Officer's immediate family engages in such an activity or has such a relationship. The Cover Person should also obtain written approval by FT's General Counsel in such situations. 3. Franklin Resources General Counsel and Deputy General Counsel are authorized to consult, as appropriate, with members of the Audit Committee, counsel to the FT Funds and counsel to the Independent Directors, and are encouraged to do so. 4. Item 2 of Form N-CSR defines "waiver" as "the approval by the registrant of a material departure from a provision of the code of ethics" and "implicit waiver," which must also be disclosed, as "the registrant's failure to take action within a reasonable period of time regarding a material departure from a provision of the code of ethics that has been made known to an executive officer" of the registrant. See Part X. 5. See Part X. EX-99.CERT 3 fmsf302certs_0609.txt 302 CERTS Exhibit 12(a)(2) I, Laura F. Fergerson, certify that: 1. I have reviewed this report on Form N-CSR of FRANKLIN MUTUAL SERIES FUNDS; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. 8/27/2009 S\ LAURA F. FERGERSON Laura F. Fergerson Chief Executive Officer - Finance and Administration I, Matthew T. Hinkle, certify that: 1. I have reviewed this report on Form N-CSR of FRANKLIN MUTUAL SERIES FUNDS; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. 8/27/2009 S\ MATTHEW T. HINKLE Matthew T. Hinkle Chief Financial Officer and Chief Accounting Officer EX-99.906CERT 4 fmsf906certs_0609.txt 906 CERTS Exhibit 12(b) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Laura F. Fergerson, Chief Executive Officer of the FRANKLIN MUTUAL SERIES FUNDS (the "Registrant"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The periodic report on Form N-CSR of the Registrant for the period ended 6/30/2009 (the "Form N-CSR") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Form N-CSR fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Dated: 8/27/2009 S\ LAURA F. FERGERSON Laura F. Fergerson Chief Executive Officer - Finance and Administration CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Matthew T. Hinkle, Chief Financial Officer of the FRANKLIN MUTUAL SERIES FUNDS (the "Registrant"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The periodic report on Form N-CSR of the Registrant for the period ended 6/30/2009 (the "Form N-CSR") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Form N-CSR fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Dated: 8/27/2009 S\ MATTHEW T. HINKLE Matthew T. Hinkle Chief Financial Officer and Chief Accounting Officer -----END PRIVACY-ENHANCED MESSAGE-----